西式醫藥服務 (WST) 2005 Q1 法說會逐字稿

Welcome to the West Pharmaceuticals Services First Quarter 2005 results call. [OPERATOR INSTRUCTIONS.]

Today’s conference is being recorded. If you have any objections, you may disconnect at this time.

Now, I will turn the meeting over to Ms. Julie Wang of Financial Dynamics. Ms. Wang, you may begin.

Thank you, Operator. Good morning, everyone, and welcome to the West Pharmaceuticals Systems 2005 First Quarter Conference Call. As you know, we issued our results this morning. The release has been posted on the company’s Web site located at www.westpharma.com. If you have not received a copy of this announcement, please call Financial Dynamics at 212-850-5628, and a copy will be sent to you immediately.

Before you 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,” “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 views expressed in any forward-looking statements, and are dependent upon a number of factors. A non-explicit (ph) list of those factors is listed in the company’s press release and SEC filings.

In addition, for the purpose of evading comparisons, period results references made on this conference call and in today’s press release is historic expected financial results determined by excluding certain costs to non-recurring items. These re-measured period results are not with the U.S. 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, and certainly not as a substitute, for the related GAAP financial measures. A reconciliation of these measures can be found in today’s release.

This call is being recorded on behalf of West Pharmaceutical Services, and is copyrighted material. It cannot be re-recorded or rebroadcast without the company’s expressed permission. Your participation on this call implies your consent to our taping. Once management has concluded their remarks, we will open the floor for questions.

With us this morning are Don -- Dr. Don Morel, Chairman and CEO, William Federici, Chief Financial Officer, and Mike Anderson, Vice-President and Treasurer, and West’s primary Investor Relations contact.

At this time, I would like to turn the call over to Don Morel. Don, please begin.

Thank you, Julie, and good morning, everyone. As Julie indicated, joining me for the call this morning are Bill Federici, our Chief Financial Officer, and Mike Anderson, our primary Investor Relations contact and corporate treasurer. I'd first like to make a few brief remarks on our operations, and then I'll turn the call over to Bill Federici for a more detailed discussion of our financial results.

The company's first quarter results released this morning indicate the year is off to a very good start. Sales growth in our core components business was 15% versus the first quarter of 2004, 3% of which was due to currency. Our gross margin, again on an at-reported basis, improved from 30.3% to 31.1%. Net income from continuing operations was $13 million, or $0.41 per share, versus $8.9 million, or $0.30 per share, in 2004. Our non-GAAP pro forma earnings for the first quarter of last year were $0.35 per share.

Sales growth during the quarter was slightly ahead of our original expectations, and resulted from several factors -- an overall positive product mix, growth in demand for our core packaging and medical device components, no softening in demand for coated closures, as was originally forecast, continued strong demand for Westar treated products, and growing demand for analytical laboratory services, and our development and tooling services.

From a geographic perspective, excluding currency, sales growth in dollar terms was split evenly between the Americas and the Europe-Asia-Pacific region. Growth in the Americas was again driven by solid demand for Westar, and coated closures for the biotechnology segment, in addition to demand for engineering and laboratory services. In Europe, growth contributors were continued strong sales of seals and closures for the diabetes market, and higher than historical demand for disposable medical devices. Europe also benefited from a shift in sales demand by several key customers from the fourth quarter of 2004 into the first quarter of 2005.

At the end of the quarter, our backlog declined approximately $12 million versus the comparable period in 2004. This is likely due to a combination of reduced Teflon and B2 safety stock orders due to the raw materials change in 2004, the work-off of Kinston safety orders, and improved delivery performance by the operating units. However, it should be noted that our backlog at the close of the first quarter of 2004 was the highest in the company's history. Our current backlog of just over $150 million represents slightly more than one quarter’s sales, looking forward.

The company also achieved two other significant milestones during the quarter. First, in the Americas region, we secured our first orders for the Clip‘n’Ject reconstitution system, which will be used in combination with a drug for the treatment of prostate cancer. Although small in unit terms, for the near-term, getting the system into commercial sales is a substantial achievement.

Second, West announced the launch of West Spectra, a new product in our line of seals that can be incorporated as an anti-counterfeiting measure.

Let me now turn briefly to Kinston. As indicated in our February call, the plant is now operating at its planned production capacity. Our manufacturing efficiency has steadily improved throughout the first quarter, with the plant’s operations effectively breaking even for the month of March. Although we will continue to experience a range of challenges at the plant operates under a full shift load going forward, we now believe the operation will return to profitability by mid-year.

And now, I’d like to turn the call over to Bill Federici, who will discuss our financial performance in more detail for the quarter. Bill?

Thank you, Don, and good morning, everyone.

As indicated in this morning's press release, West reported first quarter 2005 income from continuing operations of $13 million, or $0.41 per diluted share versus income from continuing operations of $8.9 million, or $0.30 per diluted share recorded in the first quarter of 2004. Reported results in this year's quarter included $500,000 of pretax cost equal to $0.01 per share related to the company's election to adopt SFAS 123R, which requires expensing of stock options. Reported results in last year's first quarter included $3.8 million pretax, or $0.08 per diluted share of incremental costs associated with the company’s plan to replace production from its Kinston plant, and other Kinston accident-related costs. The 2004 first quarter also included a $600,000 non-operating gain from the sale of an affiliate’s plant in Mexico that was shut down in a 2002 restructuring.

Providing more relevant comparison of ongoing operating results, we provided a non-GAAP analysis in our release that adjusts for the effect that these differences in last year's first quarter. Also excluded in the analysis is the profit impact in both years of the results of the company's discontinued operations, the former drug delivery division. After excluding all of these items, first quarter 2005 earnings were $0.41 per diluted share, $0.06 greater than 2004 Q1 earnings of $0.35 per share.

The company's core operating division performed very well in the quarter, with sales of $149.5 million, nearly 15% above 2004 first quarter sales, with 3% of the sales increase due to currency. Unit sales growth was approximately 3%. A rich product mix, value capture initiatives, and price increases accounted for the remainder of the sales increase.

Domestic sales grew by almost 13% over same period 2004 sales, and sales in our international markets grew by more than 16% above prior year sales, nearly 5% of which was due to currency. All of the division’s geographic regions experienced substantial year-over-year revenue growth, driven by continued growth in demand for the company's high value advanced coatings and Westar line of products. Disposable medical device sales grew by 7%, and demand also increased for consumer goods packaging components, and for the company's customized seals, developed to combat drug counterfeiting.

The following other items also contributed to this sales increase -- the pass-through effect of raw material price increases, a higher level of customer funded product development and production tooling projects, revenue recognition for these value-added services commenced in the second quarter of 2004. Customer accommodation shipments with planned deliveries for other quarters totaling approximately $2.5 million were delivered in Q1 2005. Excluding these items, sales increased approximately 8% over first quarter 2004 sales.

As noted in our release, consolidated gross profit margins for the quarter were 31.1% versus the 30.3% margins achieved in the same quarter of 2004. As noted previously, 2004 first quarter results included various Kinston accident-related costs totaling 3.2 million pretax, most of which were not included in this year's quarter. Excluding the Kinston costs from the 2004 quarter, the non-GAAP gross margin was 32.8%.

With the resumption of normal production activities in Kinston, however, added depreciation, labor, overtime, fringe benefits utilities, training and other continuing plant overhead costs have been incurred, resulting in a first quarter operating loss for Kinston. Most of these costs are expected to continue into the future, but efficiencies at the plant are also expected to improve steadily through the remainder of the year. We expect Kinston to be operating profitably by mid-year. The impact of increased sales volumes and the favorable product mix referred to earlier in North America and Europe partially offset the increased costs associated with bringing the rebuilt Kinston facility back on stream.

Consolidated selling, general and administrative expenses increased slightly by $100,000 in the quarter versus the prior year quarter. The increase is due to expense associated with the company's incentive-based restricted stock plan implemented in the second quarter of 2004, the effect of expensing stock options for the first time, and the impact of foreign exchange. Increases were largely offset by the effect of the decline in our stock price on director compensation, lower incentive compensation cost, and reduced outside service costs. As a percentage of sales, quarter one 2005 SG&A expenses decreased by approximately 2 percentage points from first quarter 2004 levels.

Reported consolidated operating profit was $20.1 million in the quarter versus $13.6 million in the 2004 first quarter. On a non-GAAP basis, adding back the Kinston costs to the 2004 quarter, operating profits as a percentage of sales were 13.3%, essentially even with our 2005 quarter one operating profit margin of 13.5%. Net interest expense was 2 million in the quarter, slightly higher than last year's first quarter expense of 1.9 million, due to increased borrowing rates. The company's effective tax rate declined from 31.6% from 32.8% in the prior year quarter due to the geographic mix of earnings.

The company's cash balance at March 31st was $54 million, and working capital totaled $124 million. Debt at March 31st was $152.7 million, a decline from the year-end position of $160.8 million. The debt to total invested capital ratio at the quarter-end was 33.2%, continuing its consistent decline. Capital expenditures during the quarter were $8.1 million, with more than 85% of the year-to-date capital focused on new and replacement manufacturing equipment and tooling, mostly in North America and Europe.

We were able to repatriate $9 million of previously unremitted foreign earnings in March, and another 5 million in April. The 9 million was used to repay debt in March, and the 5 million repatriated in April will also be used to pay down debt. Our plans with respect to repatriation of the additional unremitted foreign earnings of up to $70 million are on hold, pending the passage of a technical correction -- technical correction act to the AJCA. While we originally anticipated a quarter one passage of the technical correction, we are told it may be held up by attaching it to another spending bill. Without this technical correction, our ability to affect the repatriations in a tax efficient manner would have to be reevaluated. We were able to repatriate the $14 million by utilizing previously existing unbenefited foreign tax credits to offset the additional tax on repatriation.

I also wanted to announce our intention to issue earnings releases in future quarters after markets close on the day before our conference call is scheduled.

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

Thanks very much, Bill.

In assessing the outlook for the second quarter and the full year, our performance during the first year has set the stage for a good operating year. Our order book for the second quarter looks very good, with a substantial percent of planned sales currently in the production system. We now believe in our overall sales growth for the full year will fall in the range of 6% to 8%, excluding currency, and that our earnings will be at the upper end of the guidance provided in February of $1.37 to $1.47 per diluted share.

Although we are optimistic about the year, there are still some factors beyond our control that warrant close observation. We have effectively mitigated the impact of raw material increases to date through a combination of price increases, contracted price escalators, and expense controls. However, there are likely to be further increases for selected materials as 2005 progresses.

Also, the second half of our year has historically been a bit more difficult to forecast due to plant shutdowns in Europe for the summer holiday period, and customer production adjustments toward year-end. In addition, although we did not see the softening anticipated in orders for our Teflon and B2 coated closures during the first quarter, this may still result in some unevenness in our second half revenues, as customers adjust inventories accordingly.

That concludes our remarks for this morning. We'd now be pleased to answer any questions that you might have.

[OPERATOR INSTRUCTIONS.]

There are no questions at this time. Excuse me, we do have a question from Steven Postal (ph). Your line is open.

Can you just elaborate on how you are managing through the increase in commodity costs, and your ability to pass any of those increased costs along to your customers?

Sure. As you know, we basically have a series of price escalators in our agreements with our resin-based customers that allow us, on a quarterly basis, to adjust. So, although our ability to recover the increase has lagged a little bit, we eventually do get it back.

In our other contracts that are typically multi-year supply contracts, those are adjusted on an annual basis, and that covers about 45 to 50% of our revenue base. The remaining 50% we typically run through pricing at the beginning of the year, and it’s the combination of the escalators and the ability to price on that half of the contracts that aren’t covered by long-term agreements that allow us to mitigate the price increases.

I mean, the other thing that we’ve done is very effectively control our general cost structure in our plants in the first quarter. We’re pretty pleased with our ability to mitigate those raw material price increases to date.

And as I recall, you kind of began talking about raw material costs I think in October with the September quarter earnings release. How would you compare your views of the impact from raw material costs to when you began talking about it about six months ago?

I think that we basically have seen -- I wouldn’t call it a peak in the pricing, but we think we’re probably through the worst of it. We’re going to see some other changes as we go through the year. In the first quarter, we effectively were on our expectations, I think. The truth is that, as the second quarter evolved, as I said in my comments, we are expecting some other increases to come through the system, and we’ll have to manage accordingly. You can believe anything you want about what the pundits are saying in terms of oil prices up and down. I think, for the majority of our raw materials, we’re basically at our expectation in terms of first quarter.

I know you talked a little bit about managing costs. It seems pretty impressive to me. Can you just elaborate on those initiatives for cost management and how we should view SG&A growth for the next few quarters?

Steven, it’s -- we are happy, as well, with the results in the SG&A controls.

Part of it was due to the fact that our stock price was down and, on incentive comp, that has an impact. But as it relates to our plants and production, we've worked pretty well with the operating guys in terms of making sure they understand what's driving the cost and, where they are discretionary, we're trying to put controls on them. We also have talked about in the past that we've initiated a lean initiative, and we fully expect that we'll be able to continue to look at not only cost as it relates to the production of our products, but also corporate costs and other overhead costs as we go forward.

The only other comment I'd make there, Steven, is that the operating units in particular in Europe and North America, in conjunction with our account reps, have been pretty effective in the early part of the year, and staggering orders for the production system such that our plants are pretty level loaded. And the better we do that, the better we can manage our cost structure. So, those guys were particularly good in the first quarter.

And then, I guess just one final question from me. Gross margin, I vaguely recall you had an expectation for full year I think around 30%. Can you just update as best you can any kind of view on where the gross margin will turn out for the full year?

We're still -- obviously, we've upped our guidance to the top end of the range, so we are expecting some benefit in there. We're looking at for the first quarter, obviously we had some benefit in there above the 30%, but we do see some downstream impacts on mix and the increase of, as we talked before, of raw material labor and overhead costs. So, we haven't changed that number, the 30% number. It's plus or minus some percentage in there, but we're going to stick with our 30% for the time being, full knowing that we've got -- we’re going to be towards the upper end of our range, so there is some, probably on the upside, I'm looking at that from a plus or minus perspective.

The only qualifier there, Steven, is that, as you know, looking at our historical patterns, the first half of the year is typically a little bit stronger than the second half, and the second half for us is a little bit more difficult to forecast because we do go through the plant shutdowns. Our customers do go through their year- end inventory adjustments. So, for the first half of the year, you're probably going to see it be slightly higher than the 30 average that we talked about, and it may be that in the second half of the year it comes down a little bit. But, as Bill said, we'll probably be a little north of the 30 figure for the full year.

If I had -- and maybe this isn't completely appropriate -- but to break it down into a few buckets -- mix, raw material cost and maybe inventory changes at your customers, what would kind of be your biggest source of concern, where you'd want to be the most conservative on?

It's really in the mix area.

[OPERATOR INSTRUCTIONS.]

Greg McCosco (ph), Lord Abbett.

You talked a little bit about inventory builds. How do you track that, and how do you know that in terms of your end customers?

You track it as best as you can through your account representatives, and trying to get the orders into your plant as soon as you can. Obviously, we track it through backlog, and we segment our backlog according to market segment, really. But most of it is done predominantly at the interface between the account reps and the customer.

And as I remember, you had felt that those inventories may have built a bit at the end of the fourth quarter, I believe, and I guess they were not as -- perhaps as strong as you thought?

I think there’s a couple of things that we probably ought to clarify. The inventory builds occurred in a couple of different areas. We think that throughout the end of 2003 and early into ’04, certain customers were building safety stocks in the aftermath of Kinston, and that was more on the med device side. As we got to the end of ’03 and early into ’04, we had the issue with the two raw material changes. Those we had a little bit more visibility into because customers ordered safety stock with the existing materials to produce product, while they also ordered duplicate stocks with the new composition so they could do their stability trials to get the new formulation paperwork done and submitted as part of their application update. So, there’s really two parts to that.

What we haven’t seen in the first quarter is we thought that we would see a little bit of softening as they worked out that second inventory piece with the old materials, and eventually, through the year, started to reorder again, to rebuild with the new materials.

And that, in fact, what you’re saying is it has not happened?

It hasn’t happened yet. Again it’s one of those things we need to keep an eye on as the year progresses.

And if we look at the revenue growth, what you’re saying is, because the first half is typically stronger than the second half, that’s why we’re seeing something significantly above that 6 to 8% range that you gauge for the year?

We also had some special items in there, as I tried to cull out for you, Greg. We had some with tooling orders, those value-added -- revenue recognition for those value-added services didn’t commence until the second quarter of ’04, so, in the first quarter that you’re comparing it to of ’04, there were no -- there was none in there, very small amount, actually.

And also, we had a bit of customer accommodation, where they wanted some -- they wanted their delivery of products in a different quarter than we originally had planned for it, so that was another piece of the puzzle. So, when you try to carve those out -- and it’s not an exact science -- but if you look at the impact of those on that 12% real growth number, the real growth is more in the 8% range.

And the unit sales is 3%, so we’re talking 5% pricing, or something?

Well, it’s hard to do that. Because of the way our sales are, the different types of sales that we have, the mix of sales is very important on how that plays out. But yes, the units were approximately 3%, and that’s a blended rate, obviously, and the remainder of it is either -- it’s the mix issue, it’s price increase, and it’s the value capture initiatives.

OK, and so it’s fair to say that this is kind of a, shall we say, an anomaly in the first quarter with these pass-throughs and tooling and things like that?

Well, the tooling will continue. As Don mentioned, we’re seeing increase. We especially looked at that as an area where we can provide value-added services to our customers, and we’re billing them for it now. So, yes, that’s going to continue, and that will continue to grow. But yes, there is -- this quarter specifically, there were some special items in there that really pumped the number up.

And your customers are reasonably all right with those -- with that tooling charge and the like?

They -- it’s part of the accommodation that we make for them.

Yes, it’s typically contracted on a customer-by-customer basis. We haven’t seen any resistance in terms of development and engineering services, which is really where you’d kind of expect it. But clearly, we’re putting much more effort in at the customer interface, especially early on in development projects where we need to recoup our costs. Our focus on that is one of the things that’s contributed to some of the revenue growth, albeit off a small base but, combined with the analytical services we provide, it’s one we’ll expect to continue to grow in the quarters ahead.

And then finally, if you would, just give me some color on the diabetes side. You said that was a strong factor in terms of growth rate, etc. What was the nature of that? Were those syringes? Was it--?

--That’s a combination of vials and pre-filled syringes, but all you have to do is look at the growth in diabetes around the globe, and our units are going to track that.

Do you benefit from the insulin pump in that? Does that -- other than the vials?

No, our components are typically sold for vial-based insulin and disposable syringe use, as well as cartridges that go into the multiple dose system.

David Schneider (ph), Hoover Investment Management.

I was wondering if you’d give me what the number was for depreciation and amortization for the quarter? And also, I get a lot of information from the FDA, and there was a recent statistic suggesting that as large as one out of seven prescription drugs that people take are counterfeit, which was really surprising to me. And I’m just wondering, as far as if you can give us almost a sense of if you have an idea of how much you have to go. Are we at the very beginning of you really attacking that area and taking advantage of it, or are we midway through that effort?

On the counterfeiting issue, we’re really at the entry stage of this in terms of products that counterfeited. I think what you have to do is cull out the FDA’s data in terms of oral dosage versus injectible dosage. The counterfeiting trends that we have observed around the world through our customers tend to be on the very high value biotech side. And as we talked about in prior calls, our development efforts are looked at different technologies like West Spectra on the seal side, that contribute to package integrity and make it much more difficult for counterfeiters to reproduce the external packaging components.

In the future, what you’re going to see are more sophisticated technologies that we’re working on, where you have, for example, RFID embedded underneath the seal as part of the tracking during production, and also, once it’s in the field, as well as the ability to verify its authenticity. So, I think a lot of the issues to date that have hit statistical base for the FDA have to do with drugs -- lifestyle drugs, for example anti-impotence drugs, and the cholesterol type of drugs that are a little bit more susceptible. We think it’s the beginning of a trend. We think it’s a significant market opportunity, and we have a significant effort underway inside, both in terms of just simple package modifications with the seal, as well as more advanced technologies. Bill, you want to--?

--Yes. David, the DNA for the quarter was $10 million.

There are no further questions.

Thank you very much, Operator.

I’m very pleased with the company’s performance during the first quarter, and believe that our excellent first quarter results put the company in a good position to achieve our performance targets for the full year. There are still some areas that require careful attention, including the composition of our backlog, raw materials cost, Kinston’s operating performance through the remainder of the year, and customer inventory strategies.

However, our capital investments over the past two years have given us the capacity and key product lines to satisfy increasing market demand. It’s also clear that our strategic focus on market segmentation is yielding the desired result in terms of value capture for our products and services. Although there are many challenges ahead, I remain confident that West is well positioned to generate sustainable revenue and profit growth in our core components business over the next several years.

Finally, for those interested, West’s annual shareholder’s meeting will take place at our Lionville, Pennsylvania headquarters on Tuesday, April 26th, starting at 9:30 a.m. In addition, as with last year, the annual meeting will be Web cast.

Thanks very much for your time today.