西式醫藥服務 (WST) 2012 Q2 法說會逐字稿

Welcome to the West Pharmaceutical Services second quarter 2012 conference call. At this time all participants are in a listen-only mode.

This call is being recorded on behalf of West and is copyrighted material. It cannot be rerecorded or rebroadcast without the Company's express permission. Your participation in this call implies your consent to our taping. If you have any objection you may disconnect at this time.

Now I would like to turn today's meeting over to Mr. John Woolford from Westwicke PartnersSir, you may begin.

Thank you, operator. Good morning everyone and welcome to West's second quarter 2012 results conference call. We issued our financial results this morning, and the release has been posted in the investor section on the Company's website located at www. Westpharma.com. If you have not received a copy of this announcement please call 443-213-0500 and a copy will be sent to you immediately. Posted on the Company's website is a slide presentation that management will refer to in their remarks today.

The presentation is in pdf format. Should you require it a link to a free download of software that will enable users to view the presentation is also available on the website.

I remind you that statements made by management on this call and in the presentation will contain forward-looking statements within the meaning of U.S. Federal securities law and are based on management's beliefs and assumptions, current expectations, estimates and forecasts. Statements that are not historical facts including statements that are preceded by, followed by or include words such as estimate, expect, intend, believe, plan, anticipate and other words and terms of similar meaning are forward-looking statements. West's estimated or anticipated future results, product performance or non-historical facts are facts are forward looking and reflect our current perspective on existing trends and information.

Many of the factors that will determine the Company's future results are beyond the ability of the Company to control or predict. These statements are subject to known or unknown risks and actual results could differ materially from past results and those expressed or implied in any forward looking statement. You should bear this in mind as you consider forward looking statements. For a non-exclusive list of factors which could cause actual results to differ from expectations please refer to today's press release. Investors are also advised to consult any further disclosures the Company makes on related subjects in the Company's 10-K, 10-Q, and 8-K reports. Except by applicable securities law the Company undertakes no obligation to publicly update forward-looking statements whether as a result of new information, future events or otherwise .

In addition, during today's call, management may make reference to non-GAAP financial measures including adjusted operating profit and adjusted dilute EPS. These measures and their component parts have no standardized meaning prescribed by U.S. GAAP and therefore may not be comparable to and should not be viewed as a substitute for U.S. GAAP operating income and diluted EPS. Reconciliations of the non-GAAP measures to the most comparable financial results prepared in conformity to GAAP are provided in materials accompanying this morning's earnings release. At this time I would like to turn the call over to Don Morel our Chairman and CEO

Thank you very much John and good morning everyone. Welcome to West's second quarter 2012 conference call. I am joined this morning by Bill Federici, our Chief Financial Officer, and Mike Anderson our Treasurer and primary Investor Relations contact. As a reminder, we will refer to the slide deck John mentioned in our prepared remarks this morning. The slides can be found through our website www. Westpharma.com under Investors. However, if you have difficulty accessing the file, the content of those slides is covered both in this morning's release and in our commentary.

As we presented in our April call, 2012 started strongly and indeed that momentum has carried through the second quarter. For the last three months as highlighted on slide three and in the release. West generated record consolidated sales of $324.8 million representing a 5.5% growth at actual rates or 11.3% excluding the effects of currency exchange versus the second quarter of 2011.

Our sales growth resulted from a favorable product mix and when combined with pricing actions from earlier in the year, improved plant operating efficiencies and lien initiatives, our gross margin increased by 2.9 percentage points to 30.4%. Although SG&A rose moderately, second quarter operated income was $39.5 millionyielding very strong quarterly adjusted diluted earnings per share of $0.79 cents. Order patterns remained favorable with approximately 85% of expected third quarter production booked and our confirmed backlog remains at a very healthy $305 million, approximately 10% higher than the same period in 2011.

As a result of our strong first half and our visibility in demand in the next six months we are increasing our adjusted EPS guidance to $2.60 to $2.70 per share even with the head wind of the strengthening dollar and an assumed Euro conversion rate of $1.22 for the remainder of the year. Bill will cover our results and guidance forecast in greater detail.

So I will offer a few observations on the business units as summarized in slide four. Pharmaceutical packaging sales grew 13.1% excluding currency again driven by continued strong demand for value added products including Envision, FluroTec and Westar. Collectively, high value products grew 28% at constant exchange rates resulting in a very positive product mix despite the currency drag in Europe created by the strengthening dollar. We also experienced solid standard product growth as customers continued to rebuild inventories and certain generic customers ramped up production to meet market shortages of selected drugs.

Overall sales were up in all geographic regions led by an almost 20% gain in Asia and more than 10% in Europe excluding exchange effects. As a result of the positive product mix and plant operating efficiencies, the segment operating margin improved to 22%, significantly above our stated 5-year business plan objective for the packaging business. We also benefited from relatively stable raw material costs and improved plant utilization when compared with 2011. While there no doubt will be fluctuations in the margin of future quarters we still believe this part of the business can deliver a 20% or higher operating margin on a consistent annual basis. Certainly the primary drivers of our business over the next few years remain intact led by an aging population with an increasing incidence of chronic disease treated with injectable drugs of biologic origin.

Sales in the delivery system segment grew 6.1% due to strong demand for contract manufacturing services, reconstitution systems and continued improvement sales of safety systems. CZ sales were flat compared with the prior year primarily due to customer delay in launching a new product in the U.S. On a positive note, we did book two significant orders for CZ systems in the quarter for future stability trials, and also announced our collaboration with Amgen to develop and evaluate CZ systems. Per our June 20th release, the terms and details of that collaboration are bound by confidentially and thus not subject to further comment.

Operating profit for the segment improved versus the prior year, helped by customer funded development projects. Overall, we continue to make good progress toward our strategic objective of shifting the mix in this segment from approximately 80%-20% contract proprietary to 50%-50% within the next five years. As the mix improves, we will also see a substantial improvement in operating margin. Slide five provides highlights of our ongoing expansion and product development programs. I'll be brief here as this was covered in some detail during our May 23rd investor day.

The China elastomer facility remains on schedule and, as a reminder, should begin shipping product for validation trials late in the first quarter next year. All of the required approvals and permits have been obtained for construction of the India facility and we expect ground breaking to take place this month. The global launch of NovaPure continues to go well with customers focused on meeting the market's rising quality standards for all aspects of their drug products. The NovaPure product line builds on the quality attributes of the Westar line which was launched more than 10 years ago and has secured a significant part of the small volume printable market. Certainly the infrastructure investments we have made over the last few years are bearing fruit as much of the growth in high value product demand such as Envision is being produced in its recently installed capacity.

CZ sales for the quarter were flat compared with the prior year and remain unpredictable in the near term. But we remain confident that full-year sales will fall in the range of $8 million to $10 million for these products. While the [one-in-all] needle syringe is getting the most attention a number of recent vial recalls for delamination have started to generate market interest in alternatives to glass vials as well. As customers continue to focus on particular issues, we expect sampling activity for CZ vials to pick up in the second half of the year. Our development group continues to field numerous inquiries regarding our self-injection platforms, ConfiDose and SmartDose.

As was mentioned in our Q1 call, the primary development efforts for the SmartDose system remain focused on engineering validation of the CZ cartridge and optimizing the supply chain for the device itself. So the customers can begin planning for formal stability, patient use and clinical studies using the ultimate commercial iteration of the device. Our next major program goal remains to have validated units ready for clinical trials in mid-2013.

On a safety front, sales of the Eris system have strengthened and we are forecasting full year volumes substantially ahead of 2011 levels. We have also secured our first customer for the new B-safe system with the first production units delivered in July. In sum, the first six months of 2012 have been very strong with a great deal of progress achieved relative to our long-term goals and we expect a strong year in terms of both sales and earnings per share on a fully diluted basis. I would now like to turn the call over to Bill Federici for a more details look at our Q2 results. Bill?

Thank you, Don. Good morning, everyone. We issued our second quarter results this morning reporting net income of $15.6 million or $.45 cents per diluted share. Versus the $.57 cents over diluted share we reported in the second quarter of 2011.

Excluding the effects of special items like the current quarter's debt extinguishment loss and impairment charge and the smaller restructuring and acquisition earn out adjustments, second quarter 2012 earnings were $0.79 cents per diluted share versus the $0.62 cents we earned in Q two 2011 a net increase of 27%. Those non-GAAP measures are detailed on slides 13 to 15. The net effect of our debt refinancing activity is expected to be accretive to earnings per diluted share in future periods by eliminating the dilutive effect of the under lying 2.9 million shares associated with a tendered convertible debt.

Our current guidance indicates 2012 accretion of approximately $0.04 to $0.05 cents per share based our expected results. Turning to sales, slide six shows the components of our consolidated sales increase. Consolidated second quarter sales were a record $324.8 million, an increase of 11.3% over second quarter 2011 sales excluding exchange of [becks.]

The favorable mix and pricing added sales of $35 million in the current quarter. Packaging system sales increased by $29 million or 13.1% over same quarter 2011 sales excluding exchange effects. A favorable sales mix and modest volume increases accounted for 8.6 percentage points of the increase.

Sales price increases in packaging systems contributed the remainder of the increase. Sales growth in our high value products increased 28% versus the prior year quarter excluding exchange. Our Q2 2012 sales comparisons to the prior year period continued to benefit from a customer's product launch, customer inventory management actions and activities and advance of customer product and plant relocations. In addition, the sales price increase in the first half of 2012 reflects higher material costs incurred in 2011, but not passed on to customers until the latter part of 2011.

Excluding the positive effects for the customer inventory builds and product launch activity we estimate our normalized 2012 sales growth to be in the range of 5% to 7%. Delivery system sales increased by approximately 6% over sales in the prior year quarter excluding exchange. Sales improvements for engineering services and the Eris safety system were partially offset by lower contract manufacturing sales for consumer products. Sales of proprietary products were $18 million or 20% of the segment's revenues in the quarter, the same percentage of segment revenues as in the prior year quarter.

CZ sales and development activity were approximately $1.8 million in Q2. About $200,000 less than the prior year quarter. Total proprietary product sales are expected to grow at a double-digit rate for 2012.

As provided on slide seven, our consolidated gross margin for Q2 2012 was 30.4% versus the 27.5% margin we achieved in the second quarter of 2011. Packaging systems second quarter gross margin of 35.1% is a full four margin points higher than the 31.1% achieved in the second quarter of 2011.

High raw material prices and general inflationary increases and costs continue to put pressure on margins , but the impact was more than overcome by favorable mix of product sold. The sales price actions that took effect over the past few quarters and continued lead in savings and efficiencies in our plants. Delivery systems second quarter gross margin was unchanged versus the prior year quarter at 17.9%. Production efficiencies resulting from restructuring efforts and marginally higher selling prices were offset by an otherwise less profitable mix of contract manufacturing revenue.

In addition, our delivery system segment recorded $3.8 million in other income in connection with the development of a proprietary product. As reflected on slide eight, Q2 2012 consolidated SG&A expense increased by $8 million compared to the prior year quarter. The largest share of the increase comes from a $3 million increase in performance-based compensation expense associated with our approved -- improved operating results.

And $2.6 million of stock based compensation most of which was due to an 18.7% increase in the Company's share price during the quarter compared with a 2.3% decline in the prior year period. Slide 9 shows our key cash flow metrics.

Operating cash flow was $66 million for the first half of 2012 $16.8 million more than the comparable prior year period due primarily to our strong operating results. Capital additions of $75 million were made in the first half of 2012 including $23 million for the new corporate office facility. Roughly half of the capital was spent on new product and expansion efforts. We expect to spend between $145 million and $155 million in capital in 2012 including approximately $40 million of costs associated with our planned new corporate office and research facility.

Slide 10 provides some summary balance sheet information. Our balance sheet continues to be strong, and we are confident that our business will provide necessary future liquidity. Our cash balance at June 30th was $107 million, $15 million higher than our December 2011 balance. Additionally, not included in that cash balance is $25 million of short-term investments with maturities of less than one year. The vast majority of our cash is invested overseas and is generally not available to be repatriated to the U.S. without incurring significant tax consequences.

Debt at June 30th was $385 million, $36 million higher than at year-end primarily due to increased borrowing on our revolving credit facility including the financing of our convertible debt buy back. Our net debt to total invested capital ratio at quarter end was 29.1%, about one percentage point higher than the prior year end ratio. Working capital totaled $196.8 million at June 30th, $32 million lower than at the prior year-end.

The main reason for the decrease in working capital is due to the reclassification of $25 million of our private placement notes of the current liabilities reflecting their stated maturity date of February 2013 and $32 million of accrued new building costs which are expected to be funded within the 12 months. Our backlog of committed orders continues to strengthen which at $305 million as of June 2012 is significantly higher than the prior year-end and June 2011 balances excluding exchange and represents a continued lengthening of customer orders, a trend we believe is representative of customer inventory and risk management activities and a reaction to our increasing lead times. Based on our strong Q2 2012 results and our strengthening backlog we revised upward our full year 2012 guidance in this morning's release. That guidance is summarized on slide 11. We have based our guidance on an exchange rate of $1.22 per Euro

By contrast our 2011 actual results are translated at a $1.39 per Euro rate. The strengthening of the dollar creates adverse earning comparisons to the prior year. Each one penny strengthening of the dollar versus the Euro results in just over a one cent reduction of full year EPS as a result of translation. We now believe revenue growth will be in the 8% to 11% rate at constant exchange rates.

We believe the sales increase range includes 3% to 4% of customer inventory builds, product launch activities, and sales price adjustments which we believe are not indicative of the normal sales run rate. Our consolidated sales for 2012 should be in the range of $1.24 billionto $1.27 billion at current exchange rates. Both operating segments are expected to generate margin expansion.

Our revised guidance includes $8 million to $10 million of CZ sales for 2012. R&D funding for all programs is expected to be about $5 million more than 2011 levels. Using these assumptions our full year earnings per diluted share should fall in the range of $2.60 to $2.70 excluding restructuring costs, but including adverse currency effects.

Our prior guidance utilized an exchange ratio of $1.33 per Euro for the remainder of 2012 versus the $1.22 per Euro current rate used for our updated guidance. That adverse currency rate had the effect of reducing our guidance by approximately $0.08 to $0.10 per diluted share.

Slide 12 shows significant factors that have been evidenced in our Q2 results and which are expected to impact our margins throughout 2012. We expect a continued favorable mix shift toward high value products and lien savings programs to more than offset higher raw material costs and normal inventory cost increases. Note that the impact of the price increases over the prior year period comparisons will moderate in the second half of 2012 as we implement the price increases in the second half of 2011.

Also, our second half year results historically have been and are expected to be less profitable than the first half due to scheduled plant and customer shutdowns for maintenance and holidays. We expect these net effects will produce full year 2012 expanded margins and EPS growth. I would now like to turn the call back over to Don Morel. Don?

Thanks very much, Bill. This concludes our remarks for this morning, and we would now be pleased to answer any questions you might have. Operator?

Thank you. We will now begin the question-and-answer session. (Operator Instructions). Our first question comes from Arnold Ursaner from CJS securities. Please go ahead.

Good morning.

Jay good morning, Arnie.

The first question is a simple one for Bill. Giving the timing of convert what was your end of quarter share count or how should we think of share count on a go forward basis?

Remember at the end of the quarter we had the converts added there. You would have 2.9 million less shares, but you have to weighted average that. The convert shares were outstanding for about 170 days or so , and they are not going to be included for about just under 200 days. So when you think about it, you should use for the full year about 35.8 million shares versus what it would be if we had left them outstanding for the whole year about 37.3 million shares.

And embedded in your press release you talk about a $3.8 million of income recognized in connection with the development of a proprietary product. A couple questions about that, which area is that in? Is that in delivery?

Yes.

And I know you probably constrained about how much you can tell us, but is it a one-time, or is there where there will be legs related to it?

There will be more feeds, milestones, etc associated with that development agreement.

You can appreciate, Arnie, many of the development agreements that are customer funded are task related, so there will be lumpy revenues for delivery as we go forward.

Is there anymore built in the back half of the year for that?

For that program, yes.

There is a small amount built into the fourth quarter.

Similar to what you had this quarter?

Less than that.

And, let's see, going back to the -- in Q1 you had highlighted a pretty sizable delivery at high margin for a customer launch. Did you also have one in Q2?

The continuing effects continued into Q2 for that same launch.

But there was not a second product launch.

It is the same one, and the impact of it was felt in Q1, but continued into Q2.

Another question for Don. Your leading competitor was acquired recently. Can you comment on how you may think it will change industry dynamics ?

They actually number three -- I assume you are referring to Aptar's acquisition of Stelmi?

Correct.

Clearly Aptar has made a strategic decision to look at the injectable market. It complements their existing pharmaceutical business on the pulmonary side. They're a very strong franchise and valves for meter-dosed inhalers, it bears watching. Certainly they are going to invest and try and grow that business. Any effects will probably not be seen for, I would guess, a period of maybe three to five years because of the regulatory mode around the business.

I will jump back in queue. I had a few others, but I will jump back in queue.

Thanks, Arnie.

(Operator Instructions)Our next question comes from Ross Taylor from CL King. Please go ahead.

Hi, I just have a couple of simple questions.

(Multiple Speakers) Good morning, Ross.

Just some simple questions. The $3.8 million, I just wanted to make sure I understood or heard that is a milestone -type of payment?

It is actually a payment for development costs that we had incurred during the year.

All right. And how much of the customer inventory stocking is complete at this point? How much might it impact revenues during the second half?

I think it is difficult to put a quantitative handle on it, Ross. It has been mostly in the disposable device aisle, but it has crept over the pharma side. Our expectation is it is likely to tailor off.

My last question is I just wanted to clarify a number that Bill gave out toward the prepared -- the end of his prepared remarks, but I think he mentioned you had expected 8% to 11% organic growth on a normalized basis excluding some of these inventories?

No, That's the total number excluding exchange of 8% to 11%, Ross, and included in that number is about 3% to 4% of those things you talked about. The special non-normal run rate issues. We look at it and we say we are somewhere between 5% and 7% normalized growth.

Okay. You gave out so much detail I missed that.

Sorry about that. There is a lot of stuff going on.

That's all good. That's all my questions. Thank you.

Thanks, Ross.

We have Arnold Ursaner online with CJS Securities with a follow-up. Please go ahead.

Sure. I guess my question going back to what I was asking before to the extent I would add back -- I'm sorry, subtract out the $3.8 million one-time income from the delivery area, your margin there was dramatically lower than you have been running. I know you mentioned a lot of contract manufacturing, so first of all am I on the right track that it would have been much lower x that, and speak to the 80% of contract are these -- are you winding down previous contracts you had, and are you in fact finding some offsets that we should think about for next year to fill it in at hopefully better margin?

Let me take the first part of your question. Arnie, if you take the $3.8 million out you would also have to take out the expenses that were incurred during the year that this was a reimbursement of. So, yes, when you say it is a one-time reimbursement of prior development costs incurred. So you would have to take nearly both of them out, and you would end up somewhere close to the same number.

But your general comment about it being less of a favorable mix and therefore less profitable is true. That is in fact the case. Our proprietary device sales were 20% of total which is equivalent to what it was in the prior year , but some of those proprietary devices were at the lower end of the proprietary device margin scale. So they weren't nearly as profitable as the CZ was. And as you know, CZ was short about $200,000 compared to the prior year quarter. So those all things added together the number isn't terribly dramatically different from what we have here, but there was an impact from that $3.8 million.

But Bill, you have the expenses in a different period.

They were in the first and second quarter. Some of it was incurred in 2011, but again not all of it.

The second part of your question, Arnie, is that we haven't necessarily deemphasized the contract part of the business. It happens to be growing very robustly this year. Customer demand in the assembled devices that we're doing has been doing has been very, very strong. So that's actually rising a little bit faster than sales on the proprietary side, and because proprietary is a lot lower the ratio is maintained at that 80%-20% level. If you recall when we talked about our five-year plan at the investor day, our expectation once the validation and stability is done on many of the proprietary systems when you get into the mid-2014, mid-2915 time frame you start to get a dramatic shift in that ratio with proprietary increasing.

Just to clarify a couple of question on the backlog. I want to make sure I have the number right. Was it $305 or $320 of backlog?

$305.

And again, if it is reflecting the changing in currency, then the volume embedded in backlog is growing quite dramatically, is that correct?

The volume is actually showing fairly modest growth. What you are seeing a lot of is the effect of the mix of where you've got very high demand for the high value products and also the effect of price.

And going back to your 28% in high value products that is a very sizable number. The question I have is you did show good margin improvement, but what are the offsets? Why wouldn't you -- if the margins on your high-value products are double or triple the lower margin products, I'm surprised you wouldn't have had even stronger margin performance. What is holding it back?

You -- are you talking about -- you are talking about gross margin, and we can answer that one for you. There are increased costs associated with our raw materials were up in the packaging system space 1.2 margin points, and you had currency running the other way, and you had general inflationary costs. So a full four margin-point increase in packaging systems margins, Arnie, is pretty spectacular. And we're very happy with it. Yes, when you think about if you just took the margin differential between standard product and high value product, you are absolutely right. It is roughly closing in on being doubled. But you do have to take into consideration the raw material price increases and other general inflationary increases as an offset.

Okay. Look forward to seeing you guys at our conference. I will stop there.

Thanks, Arnie.

Thank you, our next question comes from crank from Barclays.

Hi, this is Luanna Craig for Larry Marsh's team here at Barclays.

(Multiple Speakers) Good Morning

Thank you for the questions and congratulations on a great quarter. Just a quick question on the recent agreement you announced with Amgen back in June. Have you received any additional feedback from manufacturers as a result or any additional interest in the CZ product?

CZ interest is really being driven by general market conditions. We can't comment further on the Amgen agreement, but if you follow what is happening, generally within our space and injectables concerns about delamination of glass and about breakage are getting more and more attention. Generally the market is looking at alternatives to glass in a broader sense, and That's where we see the interest.

That makes sense. Also, with NovaPure being a relatively recent launch when you think about where you are now with that launch versus where we saw you back at your analyst day, where are you guys versus your original expectations? Are customers seeing the value proposition there despite the higher prices ?

The time lag has been relatively short since investor day. The feedback we are hearing is very, very positive, but again to make these switches does not happen overnight because of the regulatory requirements. But we do believe when we look at the up take of Westar ten years ago that NovaPure will in large part follow that trajectory. So over the next six to 24 months we think we will see increases.

Great. Thanks so much. That's all I've got.

Thank you.

Thank you. That was our last question, and now I will turn the call over to Don Morel for his closing comments.

Thank you, operator, and thanks everyone for your time this morning. We look forward to talking with you again in early November when we provide our third quarter results and an early look into our revenue expectations for 2013. Thanks very much.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.