西式醫藥服務 (WST) 2006 Q2 法說會逐字稿

Good morning and welcome to the West Pharmaceutical Services Second Quarter 2006 Earnings Conference 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 your host, Ms. Julie Huang of Financial Dynamics. You may begin.

Thank you, Monica. Good morning. Welcome to the West Pharmaceutical Services Second Quarter 2006 Results Conference Call. As you know, we issued our results this morning. The release has been posted on the company's website located at www.westpharma.com. If you have not received a copy of this announcement, please call us at Financial Dynamics at 212-850-5600 and a copy will be sent to you immediately.

Before we begin, I would like to remind you that certain statements that may be made by the management of the company orally may contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These forward-looking statements set forth anticipated results based on management's plans and assumptions. Such statements give our current expectations or forecast future events. They do not relate strictly to history or current fact. In particular, these include statements concerning future actions, future performance or results of current and anticipated products, sales efforts, expenses, the outcome of contingencies such as legal proceeding and financial results. We have tried, wherever possible, to identify such statements by using words such as "estimate", "expect", "intend", "believe", "plan", "anticipate" and other words and terms of similar meaning in connection with any discussion of future operating or financial performance or condition. We cannot guarantee that any forward-looking statement will be realized if known or unknown risks or uncertainties materialize, or if underlying assumptions are inaccurate. Actual results could differ materially from past results and those expressed or implied in any forward-looking statement. For a nonexclusive list of those factors which could cause actual results to differ from expectations, please refer to the factors listed in today's press release. Investors are advised, however, to consult any further disclosures the company makes on related subjects in the company's 10-K, 10-Q and 8-K Reports. The company undertakes no obligations to publicly update forward-looking statements, whether as a result of the information, future events or otherwise. This call is being recorded on behalf of West Pharmaceutical Services and is copyrighted material. It cannot be rerecorded or rebroadcast without the company's express 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.

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

Thank you very much, Julie, and good morning. I would also like to extend a welcome to everyone joining our second quarter conference call. I'm joined today by Bill Federici, West's CFO, and Mike Anderson, our Treasurer and IR contact.

As we indicated in our earnings pre-release on July 19, the company's excellent start to the year continued through the second quarter. A strong order stream resulted in our factories operating at a very high utilization level, and the favorable product mix we experienced in the first three months of the year flowed through the second quarter. From an overall viewpoint in our pharmaceutical market, the favorable trends we discussed in our first quarter call continue to create positive demand for injectable packaging and delivery systems, and in particular, for coated and Westar processes.

Sales for the biotechnology sector again grew very significantly while sales of existing drugs grew. Several drugs on the market received approvals for new indications and products gained regulatory approval for sale. In Europe, specialized packaging for insulin delivery systems grew in line with overall market growth, and pre-filled syringe components also experienced healthy growth.

Finally, new business and conversion of pre-existing sales of standard Westar components advanced in line with expectations, supported by our recent investments in North America, Europe and Asia.

Revenues grew in all of our major operating units, leading to consolidated quarterly sales of just over $240 million, and earnings from continuing operations of $0.62 per fully-diluted share, an increase of 39% and 63%, respectively, versus the second quarter of 2005.

Our revenue growth was fueled by a combination of strong organic growth and full-quarter contributions from the acquisition of Tech and Medimop. Our balance sheet remains fundamentally very sound, with $46.1 million in cash, and a debt-to-total invested capital ratio of 39.8%.

Before Bill reviews our financial performance in greater detail, I would first like to provide some background on our operations in both Pharmaceutical Systems and the Tech Group segment.

The Pharmaceutical Systems segment continued to experience very good organic growth. Sales increased to $166.4 million overall, or just over 19%. All of our operating regions grew nicely with sales increase divided roughly equally between the Americas and Europe/Asia Pacific. In North America, growth was driven by increased demand for Westar components and generally higher demand for serum closures and packaging components utilized for [lyacholized] or freeze-dried drugs requiring reconstitution in addition to Flip-Off seals.

As previously discussed in our Q1 call, Teflon-coated product sales continued to improve during the quarter and have returned to levels we experienced before the raw material change-related surge in 2004 and subsequent softening in late 2005. The current order backlog shows this trend continuing through the end of the year.

In Europe, sales again were driven by general strong demand for standard products and continued demand for pre-filled syringe components and components used for the packaging and delivery of insulin. Also, as we commented on in our last call, we believe Europe sales have grown to some degree due to accelerated customer orders to build inventory in advance of anticipated new product launches and customer plant shutdowns for planned capacity expansion. This is the primary reason we believe there will be some degree of moderation in our sales growth during the second half of the year. However, on the whole, this is very positive news for the core business as the expansions are taking place and injectable product line experiencing solid global growth.

I am particularly pleased with the strength of our gross margin which was 36% for the quarter, an improvement of 3.7 margin points when compared with the second quarter of 2005. Most importantly, we were able to mitigate the impact of increased costs for labor, energy and raw materials through a combination of the improved efficiency of our plant operations, due largely to the impact of the our ongoing LEAN initiative, price increases implemented at the outset of the year, raw material pass-throughs and the benefit of economies of scale associated with higher production output. With a strong backlog still in place of just under $200 million, and a very good first six months, we expect the Pharmaceutical Systems segment to have a record year overall.

Turning to the Tech Group segment, second quarter sales for the Tech Group which incorporates our historical plastics molding and assembly business, plus the acquired tech business, were $76.5 million, $55.8 million of which was due to the acquisition. Demand was strong for our range of products, including disposable drug delivery systems, baby nurser assemblies, beverage closures and intercompany sales of plastic buttons used for [bio-fields] in the Pharmaceutical Systems segment. Production of the Exubera device for Nectar increased substantially during the quarter in anticipation of the third quarter launch consistent with Pfizer's previously disclosed plans. Pfizer has indicated that their physician training and patient education program would be initiated at the end of July. Sales of the product have commenced in Germany and Ireland.

The consolidated gross margin for the segment was 13.8%, a 1.7 percentage point decline versus the comparable period in 2005. For the acquired Tech Business, the gross margin was just over 13%. The margin decrease was largely the result of three factors. The lower general margin on pre-existing sales of the acquired Tech Business, lower margins on engineering and tooling revenue associated with reworking some tools and the impact of customer-driven project delays on plant utilization for several programs. As discussed in our April call, management's focus through the end of the year will be doing everything within our control to get these key programs to commercialization and the production on existing programs as efficient as possible to improve the overall margin.

I'd now like to turn the call over to Bill Federici who will provide some additional commentary on our financial performance. Bill?

Thank you, Don, and good morning everyone. We have again included with our earnings release a table that breaks out our reported results by segment and details the impact of the businesses we acquired in 2005. The table should help you follow along with my comments.

As noted in our release, West reported second quarter 2006 income from continuing operations of $20.7 million, or $0.62 per diluted share, significantly more than the income from continuing operations of $12.2 million, or $0.38 per diluted share, recorded in the second quarter of 2005.

Consolidated sales in the quarter were $240.2 million, a record level for West and a 16% increase over Q2 2005 sales, excluding acquisitions and currency effects.

The company's core Pharmaceutical Systems division performed well in the quarter with sales of $166.4 million, 16.5% above 2005 second quarter sales, excluding the impact of acquisitions and currency effects.

Growth in our international markets was once again strong with revenue growing 16.9%, again excluding acquisition and exchange effects.

The regional growth in each of Europe, Asia and South America all exceeded 15% over the prior year quarter. In Europe, the 15.5% sales growth we achieved, excluding exchange effects, was driven by continued strong demand for pharmaceutical packaging components used in both pre-filled syringe systems and vials for the high-growth insulin market and for biotech and oncology drugs. Products contributing to both our European revenue and operating profit were components coated with West's value-added advanced FloroTech product and components receiving post-manufacuring Westar treatment. As in the first quarter, some of our increased European demand related to inventory builds in anticipation of second half customer expansion-related production line shutdowns. As we reported in our last call, we expect the growth rate in Pharm Systems overall to return to a rate of high single digits throughout the remainder of the year. At this point, we do not see this pattern having a dramatic effect on our profitability as that associated with the raw material changes experienced in 2004 and 2005.

Domestic revenues in the Pharm Systems division were also strong, increasing 15.9% over the prior year. The region's most significant sales increases came from stronger demand for the company's high-value advanced coating and Westar product -- lines of products in support of the pharmaceutical markets.

The Tech Group segment, which includes West Pharma plastic unit, achieved sales of $76.5 million in the quarter, substantially greater than its prior year quarter due to the $55.9 million in sales generated by the acquired portion of the Tech Group. The acquired business increased sales substantially over those achieved in Q2 2005, most of which was under its prior ownership, due to increased volumes in pre-existing programs and a variety of new programs established with existing as well as newly-acquired customers. Sales related to our production of Nectars multi-component insulin inhalation device improved to $8.7 million in the quarter, more than twice the level of sales achieved in the first quarter.

Demand for insulin pens and other diabetes-related products also continued to increase. Sales in the Tech Group segment's previously-existing plastic unit also increased by 12% from the prior year quarter, principally due to increased sales of resealable dispensing fitments for juice product cartons and stronger demand for baby nurser assemblies and pain relief medication containers.

As noted in our release, consolidated gross profit margins for the quarter were 29.4%, versus the 29.2% margins we achieved in the same quarter of 2005. The increase is especially noteworthy considering the unfavorable impact of the relatively lower margins generated in the acquired Tech Group business which we've discussed previously. In the quarter, the margins of the acquired Tech Group business reduced consolidated gross margins by nearly 5 margin points. Gross margins in the Pharmaceutical Systems segment were especially strong, increasing over the prior year quarter by 3.7 margin points with strong improvement in both Europe/Asia and America regions.

In the Tech Group segment, gross margins declined by 1.7 margin points over the prior year quarter, due primarily to the effect of the lower margins in the acquired Tech Group business from increased low margin tooling revenues and costs associated with certain customer program delays. Price increases and higher sales volume generating increased efficiencies were slightly more than offset by increases in raw material prices, higher plant overheads and increased lab and engineering costs in the segment.

Consolidated selling and general administrative expenses increased by $5 million in the quarter versus the prior year quarter. Over 70% of the increase, or $3.6 million, relates to the incremental SG&A expense in this year's quarter from our Tech and Medimop acquisitions.

Increased compensation costs and higher costs associated with the company's U.S. pension plan account for much of the remaining increase.

As a percentage of sales, Q2 2006 SG&A expenses of 15.4% declined by 3.1 percentage points from the second quarter 2005 level of 18.5%.

Net interest expense was $2.8 million in the quarter, slightly below the expense incurred in last year's second quarter. The decrease was due to the reduced interest rates brought about by the first quarter refinancing of the company's senior notes.

Turning to the balance sheet and liquidity, the company's cash balance at June 30 was $46.1 million and working capital totaled $136.6 million. Much of the cash balance resides in Europe and we anticipate utilizing the cash to continue to pay down debt and fund our capital expansion programs. Debt at June 30 was $259.9 million, down from $281 million at year-end due to our repayment of borrowings, primarily in Europe.

The debt-to-total invested capital ratio at the quarter end was 39.8%, a decrease in the full year from year-end due mostly to our debt reduction and increased equity position.

Operating cash flows were $50.4 million in the quarter and capital expenditures were $15.4 million, with 61% of the quarter's capital focused on normal maintenance and replacement upgrades of manufacturing equipment and tooling. We now expect full-year capital expenditures to total up to $95 million, reflecting additional capital for [indiscernible] expansions in Europe and Asia to meet increasing customer demand. Our facilities in Europe are currently operating at or near capacity. As we mentioned in our last call, the stronger-than-expected customer demand we're experiencing, especially in Europe, combined with the requisite long lead times to qualify new pharmaceutical capacity, has caused this acceleration of our capacity expansion plans in Europe and Asia.

The level of spending for the remainder of 2006 is dependent on lead times for machinery equipment and demand patterns that are continuing to develop. We expect our level of capital spending will approximate $100 million per year for the next several years.

Our order backlog at June 30 remains strong at $209 million compared to last June's backlog and also to our year-end backlog of $183 million.

In summary, we have experienced very strong second quarter and year-to-date sales and operating results and expect to continue to achieve year-over-year sales and profit growth throughout the remainder of the year consistent with our revised guidance.

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

Thank you, Bill. I'd now like to comment briefly on the outlook for the remainder of the year.

Our first quarter call communicated that full-year sales for 2006 would fall between $840 and $860 million and that earnings per share would be approximately $1.68 to $1.78. However, with the strength of our core business through the first six months and the current backlog, we now believe sales will fall in the range of $880 to $900 million for the full year. On the assumption that our product mix remains favorable and in line with current trends, we now believe earnings per diluted shares will fall in the range of $1.82 to $1.88, outside of the effects of currency, costs associated with refinancing of our debt and continued increases in raw materials and energy. Also, as Bill highlighted, due to growth in several of our key markets, especially Europe and Asia and in particular China, we continue to evaluate a range of investment options to assure capacity to meet forecasted demand in the coming years. For 2006, we [just] anticipate increasing our capital spending to approximately $95 million to begin this process.

This concludes our commentary for this morning. Bill and I would now be pleased to answer any questions you may have.

Thank you. [OPERATOR INSTRUCTIONS] Our first question comes from Arnold Ursaner with CJS Securities.

Hi. Good morning. The question I have for you -- The biggest change I notice in your press release is the quite dramatic increase in capital spending, and I have a couple of questions related to that. First question I have is you have already had quite substantial capital spending both rebuilding Kinston, you've updated a lot of your facilities in terms of maintenance and other CapEx represses, you've dramatically expanded for Westar, and yet, the magnitude of the next several years of 100 million is just off the charts. Can you give us a little better feel for what is driving this dramatic change and, most importantly I think for your investors, have you carefully analyzed the return on this massive investment of capital?

I think the answer to that is in a couple of different forms. One, the growth in Europe over the last couple of years when we went through the first series of expansions in the '03-'04 timeframe due to growth in many segments of the market has actually come faster than we had originally anticipated and, as you know, with our business, we need to invest roughly two to three years ahead of time, depending on the particular type of capacity we're putting in, before we can actually begin to operate. So what you're seeing is actually investment based on our forecast for the years beyond 2007. And in particular, as it relates to the pharmaceutical market, the lead times for ordering the machinery, putting in the brick and mortar if necessary, validating, testing, get our customers to test, often pushes the commercialization time frame out quite a bit. It really, in some respects, parallels what happens in pharma. In terms of the last part of your question with regard to analysis, internally we very carefully weigh off a series of options before we make a decision, and we also have a series of hurdles that have to be hit, and we review that with our Finance Committee before we embark on any investment. So, as we go through the process, we'll continue to keep you updated. We think very positively we're basically building in anticipation of demand in the injectable market that -- but it's very positive for our business.

Again, I guess that leads to kind of a natural follow-on question. Historically, Don, you've spoken about the core business growing anywhere from 6 to 9%. Obviously, tech got faster. Given this dramatic increase in capital spending and what we've already seen in terms of growth, at what point do you have to change your view of your longer-term growth of the industry?

I think that the last three quarters in particular have seen some rather dramatic growth in injectables that results from growth in biotech and expanded indications and growth in diabetes, all the things that we've really talked about. We've also got this unusual situation where, for the first time in a long time, particularly in Europe, our customers are beginning to expand capacity in injectables and that's a very expensive and time-consuming process. I think our growth forecasts are really pretty solid for right now. I don't want to get out ahead of myself, looking a couple of years out, but as we've discussed many times, the important thing for us is to build for capacity, to build value in the business for the long-term. We look at these things very carefully before we take off on them, and I think, in terms of timing, where we're at with our plans right now is appropriate for where we think the business is going to grow.

And Ari, a couple things. The -- we haven't added bricks and mortar, a new plant, in a substantial amount of time. What we've been seeing historically over the last four years, excluding Kinston, is mostly adding machinery equipment and some bolt-bonds to existing facilities. If -- as we said, our Europe is -- Europe is at or near capacity and we're just running out of place to put -- places to put more presses to meet customer demand. If you think about the size of our -- of the average size revenue-wise of our plants, and you look at the sales growth that you talked about, the 6 to 9% in the core pharmaceutical systems business, you're talking about adding plants, each -- not each year, but certainly, you've got to come to the realization that we're going to run out of capacity very soon and we need to start thinking about building -- using bricks and mortar, actually building some green fields or adding capacity in additional bricks and mortar. The other thing about that is from a depreciation perspective. If it's buildings, it's obviously a lot longer timespan that the depreciation will come into the income statement than the M&E that we've experienced thus far. But -- and we did vet out all of these individual plans. We think we have a good matching of where, based on the lead times associated with getting these products up -- getting these commercial capacity up and running, with the customer demand associated with it. And last point is that a lot of the -- a lot of these plans are scalable. To the extent that we don't see the increases in particular markets coming in the exact timeframes that we've guessed, we can pull back the reins and slow down the step.

Three more questions related to the CapEx. Is China included in that? Number two, are your competitors who are European also expanding pretty rapidly? And three, how will you fund this since your cash flow wouldn't naturally cover that kind of capital expense?

The answer to the first question is that yes, it does include plans for China. The answer to the second question is that our competitors are experiencing growth as well and they're in the process of expanding, and the answer to your third question is we are obviously looking through a range of options on the funding. I believe a large part of it can be funded through our internal cash flows, but we are taking a look at some other options to make sure that we make optimal use of our resources.

[OPERATOR INSTRUCTIONS] We have no further questions. I'd like to turn the meeting over back to our speakers for any closing remarks.

Thank you very much, operator.

Clearly the management team is very pleased with the company's performance through the first six months of the year and, based on the level and composition of our backlog, we are in excellent position to achieve our full-year operating goals. As in past years, the expected sales growth in the second half of the year will moderate somewhat as we typically experience uncertainty due to changing customer inventory strategies and summer plant shutdowns in Europe.

However, at this point, our order book is very healthy and, in generally, our plants are operating at a very high level. Looking ahead, we need to continue to carefully monitor energy prices. The supply of our oil derived raw materials as well as the situation in Northern Israel to ensure the safety of our employees and the stability of supply to our customer base. Overall, our business is in very good position to finish the year on a strong note and is well-positioned for growth in the future. Thank you very much for your time today.

Thank you for joining today's teleconference, and you may disconnect at this time.