西式醫藥服務 (WST) 2013 Q2 法說會逐字稿

A very good day to you, ladies and gentlemen, and welcome to the West Pharmaceutical Services second quarter 2013 results 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.

And now I would like to turn today's meeting over to Mr. John Woolford from Westwicke Partners. Sir, you may begin.

Thank you, operator. Good morning, everyone, and welcome to West's second quarter 2013 results conference call. We issued our financial results this morning, and the release has been posted in the investor section of the Company's website located at www.westpharma.com.

Please note that we are issuing a corrective release, which should be available soon. We are correcting the upper end of the 2013 GAAP fully diluted EPS range to $3.28. If you have not received a copy of the announcement, please call Westwicke Partners at 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 downloadable software that will enable the 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 US federal securities laws and that are based on management's beliefs and assumptions, current expectations, estimates and forecasts. 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 or uncertainties and therefore actual results could differ materially from past results and those expressed or implied in any forward-looking statements. For a nonexclusive list of factors that could cause actual results to differ from expectations, please refer to today's press release as well as any further disclosures the Company makes on related subjects in the Company's 10-K, 10-Q and 8-K reports.

In addition, during today's call management may make reference to non-GAAP financial measures, including adjusted operating profit and adjusted diluted EPS. Reconciliations and limitations of the non-GAAP financial measures to the most comparable financial results prepared in conformity to GAAP are provided in materials accompanying in this mornings earnings release.

At this time I would like to turn the call over to Don Morel, West's Chairman and CEO. Don?

Thank you very much, John, and good morning, everyone. Welcome to West's second quarter analysts call. I'm joined by Bill Federici, West's Chief Financial Officer, and Mike Anderson, our Treasurer and primary Investor Relations contact.

As you know, West released our Q2 earnings earlier this morning, and during this call Bill and I will be discussing our recent performance and outlook for the second half of the year. As in past calls, we will refer to a Power Point slide deck to support our remarks, which can be accessed on the website via Investors. However, if you cannot access the file, the information in the slides is covered in both this morning's release and our prepared remarks.

Slide number three lays out a few highlights from the quarter and a today's announcement. First, results were positive for both businesses, with growing sales, expanding margins and higher earnings per share. Those results in the quarter are factor in raising our EPS expectations for the full year. I will come back to those in a moment and Bill will go into greater detail during his commentary.

We realized an important milestone in the quarter, receiving a $20 million exclusivity fee from a customer for the use of SmartDose in a single therapeutic area. We will recognize that income over the 13 year life of agreement, and so it is not a major factor in our current results. It is, however, a major marker in terms of the state of the technology, and while the customer and drug remain confidential, we are excited about the future prospects for this platform.

In addition to our results, we also announced we will effect a two for one stock split in September. The second split in the last ten years and is symbolic of our confidence in West's future. In connection with the split, we also announced today that West's Board approved an increase in our quarterly dividend by $0.01, effective in the fourth quarter. This increase marks the 21st consecutive yearly dividend increase for West and is also indicative of our confidence in the long-term prospects for the business.

Turning to some additional financial highlights on slide number four. Consolidated sales increased to $344.5 million, or 5.7% excluding currency effects, as a result of ongoing strong demand across both operating segments. Our consolidated gross margin for the quarter improved by 1.8 margin points to 32.2%, and operating profit improved by $3 million today's $42.5 million when compared with the prior year period. For the quarter adjusted earnings per share were $0.86, versus $0.79 during the second quarter of 2012.

Additional segment details are provided on slide number five. Sales in the Packaging System segment grew by 6.3%, and Delivery Systems grew by 4.3%, again excluding the effects of currency. Pharmaceutical Packaging sales benefited from increased sales of standard prefilled syringe components and higher selling prices.

Sales of high value products increased 3.3% versus the second quarter of 2012, which is a smaller improvement than we have seen in recent quarters, primarily due to the product growth of remarkable 28% in the prior year period. We fully expect high value product sales growth to be in the range of 10% to 12% for the second half of the year.

Delivery System sales grew as a result of strong demand for proprietary products, including CZ vials and cartridges, and proprietary devices for reconstitution and safety. Contract manufacturing revenues were slightly lower as a result of regulatory delays for two new customer projects. Overall sales of proprietary West systems accounted for 26% of total Delivery System revenues up slightly versus the first quarter of 2013, but which compares well to the 20% proprietary mix in the prior year quarter.

Operating results did not include any substantial part of the SmartDose exclusivity fee, whereas we recognized $3.8 million from development fees in the prior year quarter. In those terms the comparison is unfavorable, although this year's progress is more noteworthy in terms of the product's commercial potential.

Our current backlog of firm committed orders at June 30 is 14% higher than the second quarter of 2012 on a currency neutral basis, but decreased slightly compared with the first quarter of this year. As discussed in our May call, this sequential pattern is in line with historical norms, as customers typically order larger quantities of product early in the year. From midyear through the third quarter orders and sales slow as they focus on managing their inventories around production shutdown periods for summer and year end holiday, and as they address their year end working capital and cash flow targets.

From a pure operations standpoint we have made good progress in reducing lead times for certain key products in Europe, which also shortens order lead times, while seeing orders grow in North America and Asia. All in, we expect our backlog to come down further during the third quarter before orders begin to flowing in for 2014 in the middle of the fourth quarter. We don't expect these order patterns to adversely impact comparable sales in the second half of the year, but I will speak to our guidance in a few minutes.

Slide number six provides a brief summary of our major expansion and new product development programs. We started limited commercial production at our China elastomer facility and continue to produce test samples for lime trials and validation for other potential customers.

Construction of the India plant remains on schedule, and the expectation is that we will begin metal seal production in early 2014, followed by rubber production in 2015. Both China and India will provide much needed capacity for the region and allow increased production of high value products in our Singapore facility to support forecasted growth in the Asia Pacific market.

Sales of our proprietary Delivery System products are developing well and reached 26% of total PDS sales during the quarter. Again, driven primarily by increased sales on reconstitution systems and eris safety devices. CZ revenues, comprised of vials, cartridges and the 1 ml long syringe, were $4.8 million in the quarter, substantially higher than the modest start to 2012.

We expect double digit increases in sales of our proprietary systems during 2013 on top of the 16% increase produced in 2012. CZ revenues for the full year should fall in the range of $13 million to $15 million, and we expect sample demand to continue to fluctuate, as it depends entirely on customer requirements and timing for clinical trials and process development.

Development work on the proprietary SmartDose infusion system is progressing on schedule. During the quarter West also completed the first in-human study using healthcare providers to place the device on subjects, and the results were extremely positive, with excellent feedback regarding minimal discomfort levels at the injection site.

Turning to our outlook for the remainder of 2013, as outlined on slide number seven and in this morning's release, we believe sales growth for the year will fall between 6% and 9% at constant exchange rates, yielding revenues in the range of $1.35 billion to $1.39 billion at currently forecasted exchange rates. The primary driver for Packaging Systems will be our high value product line, whereas in Delivery Systems the ongoing shift to proprietary products and steadying demand for content manufacturing will be key.

We are forecasting improvement in our full year consolidated gross margin, which when coupled with our expectations for SG&A and R&D spending, should produce full year adjusted earnings in the range of $3.10 to $3.25 at currently assumed rates.

We believe the Company is well positioned to generate revenue growth in line with our long-term objectives and remain firmly committed to our strategy of focusing on expansion of our value added product lines in Packaging Systems while continuing to invest in technologies and products in the PDS segment to address currently unmet market needs. In keeping with our historic practice, we plan to provide preliminary revenue guidance for 2014 and our revised long-term outlook on the Q3 call in November, and earnings guidance in our year end call in February of next year.

I would now like to turn the call over to Bill Federici for a more detailed discussion of our financial results. Bill?

Thank you, Don, and good morning, everyone.

We issued our second quarter results this morning, reporting net income of $30.2 million or $0.86 per diluted share, versus the $0.45 per diluted share we reported in the second quarter of 2012. Second quarter 2012 earnings were $0.79 per diluted share after excluding the effects of special items, notably the Q2 2012 charge for refinancing our convertible debt. The effects of special items in this year's second quarter were insignificant. The non-GAAP measures are detailed on slides 15 through 17.

Turning to sales, slide eight shows the components of our consolidated sales increase. Consolidated second quarter sales were $344.5 million, an increase of 5.7% over second quarter 2012 sales, excluding exchange. Packaging System sales increased by $15 million or 6.3% over same quarter 2012 sales, excluding exchange. Volume increases, especially in Europe, accounted for 4.2 percentage points of the increase. Sales price increases contributed the remaining 2.1 percentage points.

Sales in our high value products increased 3.3% versus the prior year quarter, excluding exchange. Standard Packaging components grew 7.4%, excluding exchange. While high value products grew a modest 3.3% in the current quarter, you may recall that our Q2 2012 high value product sales had increased 28% over its prior year comparator.

Since Q4 of 2011 high value product sales have enjoyed double digit increases versus their prior year comps. While the Q2 comparison was particularly challenging, we expect that high value product sales will show double digit growth for the second half of 2013 and for the full year.

Delivery Systems sales increased by approximately 4.3% over the prior year quarter, excluding exchange. Sales improvements for CZ and administration systems partially offset by lower contract manufacturing sales. Sales of proprietary products were $24 million or 26% of the segment's revenues in the quarter, an increase of nearly 6 percentage points over the prior year quarter.

CZ sales and development activity were approximately $4.8 million in Q2, about $3 million higher than the prior year quarter. CZ cartridge sampling sales accounted for the majority of the increase.

As provided on slide nine, our consolidated gross profit margin for Q2 2013 was 32.2%, versus the 30.4% margin achieve in the second quarter of 2012. Packaging Systems' second quarter gross margin of 36.9% is 1.8 margin points higher than the 35.1% achieved in the second quarter of 2012. General inflationary increases in labor and overhead costs continue to put pressure on margins, but the impact was more than overcome by higher selling prices, continued lean savings and efficiencies in our plant, and smaller than expected increases in raw material costs.

Delivery Systems' second quarter gross margin increased 1.6 margin points versus the prior year quarter to 19.5%. Production efficiencies, higher selling prices, and a favorable mix of products sold were partially offset by increased labor and material costs.

In June 2013 we received a $20 million exclusivity payment for SmartDose covering a specific therapeutic area. The $20 million is included in cash at June 30, 2013, and will be recognized as income over the 13 year life of the contract. As a result, other income compares unfavorably to the $3.8 million of development related income recorded in the 2012 second quarter.

As reflected on slide ten, Q2 2013 consolidated SG&A expense increased by $5.3 million compared to the prior year quarter due to increases in performance based compensation expense associated with our improved operating results, inflationary increases in salaries and related costs, increased outside service costs related to supply chain initiatives and legal costs, increased sales commissions and higher depreciation on our IP assets.

Slide 11 shows our key cash flow metrics. Operating cash flow was $98 million for the first half of 2013, $32 million more than the comparable prior year period, due primarily to our strong operating results and receipt of the $20 million SmartDose exclusivity payment.

Capital additions of $84 million were made in the first half of 2013, including the $35 million of accrued new headquarters costs paid in 2013. Roughly half of the remainder of the capital was spent on new products and expansion efforts. We expect to spend between $125 million and $140 million in capital in 2013, excluding the accrued building costs.

Slide 12 provides 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 30 was $191 million, $29 million higher than our December 2012 balance. The vast majority of our cash is invested overseas and generally not available to be repatriated to the US without incurring tax consequences.

Debt at June 30 was $395 million, $16 million less than at the year end, primarily due to the February maturity of our $25 million euro note, partially offset by increased borrowing on our revolving debt facility. Our net debt to total invested capital ratio at quarter end was 20.7%, about 5 percentage points lower than the prior year end ratio.

Working capital totaled $395 million at June 30, $99 million higher than at the prior year end. Approximately one third of the increase is due to the refinancing of short-term debt to long-term, one third related to the growth in the business, and remainder due to the increase in cash.

Our consolidated backlog of committed orders continues to be strong at $356 million as of June, 14% higher than the June 2012 number but about $9 million lower than the prior year end balance, excluding exchange. We believe the lower backlog is due to a combination of seasonality and customers responding to anticipated shorter lead times in our plants. We continue to believe we will see strong sales and operating results for the remainder of 2013 due to continued high value product sales and sales of proprietary Delivery Systems, both are which are expected to show full year double digit growth in 2013 versus 2012.

Don has highlighted our revised full year 2013 guidance as summarized on slide 13. I would like to call your attention to slide 14, which shows the significant factors that can be evidenced -- have been evidenced in the Q2 results and which are expected to impact our margins through the rest of 2013.

I would now like to turn the call back over to Don Morel. Don?

Thank you very much, Bill. This concludes our prepared remarks for this morning, and we now look forward to answering your questions. Operator?

Thank you very much, Don. (Operator Instructions). We have a first question from the line of Arnie Ursaner from CJS Securities. Please go ahead.

Hi, good morning.

Good morning, Arnie.

I'm sure you are highly constrained in what you can say about the exclusive agreement that you have, but let's try to take a stab at a couple of things. You mentioned it is in a single specific therapeutic area. Which area is that?

That is confidential.

Okay. And obviously SmartDose has multiple potential applications. Maybe you could go through kind of the thought process of why the customer would want the exclusive, why you would benefit from giving them an exclusive, and how you it potentially could impact other uses of this product? Let's start with that.

Sure. For the customer, of course, one of the things that is key in the marketplace is differentiation. And I think you have heard a range of folks talk about the potential for large volume infusion systems above and beyond the standard 1 ml in certain spaces for certain therapeutic categories.

We think the system has applicability for medicines that need to have a larger volume delivered, preferably outside of the healthcare setting, either the hospital or small clinics, where you ensure dosing accuracy, you ensure patient comfort, and most importantly, ease of use for patients that may be compromised in terms of their hand strength and other issues. So we think it has got a broad range of applications for us. Clearly the customer putting some skin in a complicated development project with the new technology is a good sign.

Okay. One more question regarding that. To the extent they have the exclusivity agreement and you have been going through a testing phase, has this customer taken a certain number of testing units already, and -- or more broadly when in your agreement do you expect to see commercialization or use of the product for commercial application?

The only color I can add is that we are working very, very closely with them. Clearly they have been testing devices as we have gone along, but that is about where we stand right now.

Okay. Final question from me and I will give others plenty of chances. On the gross margin in Pharma, it was particularly strong, better than we had modeled, and I think better than you had expected. And yet the sales of proprietary products grew slower than the more traditional, and yet you highlighted mix as being one of the factors driving higher gross margin. Seems a little inconsistent. Can you expand on that is a little more?

Sure, Arnie. Actually we talked about mix being a smaller part of the equation today in the second quarter. What you see is it is more about volume, especially in Europe, that was driving the -- plus we had high efficiencies in terms of throughput in the plants and our lean programs. Our inflationary pressures were not as high as we expect, especially with our -- with the raw you materials, so when you take -- we have many, many variables that work through our gross profit, and mix happened to be very, very -- not that important in this quarter.

We think that is an anomaly. We talked about the sales volume of high value products in PPS, the Pharma Packaging Systems, being low. It's being only 3.3% in the second quarter. And as Don had said and as I had already reiterated, we expect the second half to be double digit growth and for the full year to be double digit growth. So somewhat of an anomaly, related more to the prior year second quarter being as strong as it was than it is anything as it relates to the current year's second quarter.

The only color I would add to that, Arnie, is we saw very strong sales of prebuilt syringe components out of our standard product line. So a positive there for sure.

Mostly volume related, Arnie.

Okay.

Thank you very much for your questions, Arnie. We have the next question from the line of Dave Windley from Jefferies. Please go ahead.

Hi, good morning. Sean Dodge on for Dave. Bill, we have seen inventory building be helpful on the Packaging side in the past. Curious to know what extent if any that played a role in the second quarter, or are we largely beyond that now?

Well, it did not have as much of a role in the second quarter, as you saw. However, whether that is the end of that is or not remains to be seen. We are, again, reiterating that we expect the high value products to continue to show double digit growth in the back half of the year and for the full year of 2013.

Each individual customer is different, Sean. I can tell you that they all have different stories. It really is a customer by customer basis. We did not see as much inventory building in the second quarter. If you look at the backlog, sequentially the backlog is actually down versus slightly versus December's backlog, but still up healthy over last year's second quarter.

Is it over? Really remains to be seen. Our backlog now, if you think about it, as we have mentioned in other calls, represents right around 85% to 90% of the next quarter's sales, but there are still obviously a piece of the next quarter and obviously the fourth quarter that are not known at this point in time.

So we are going into the period here in July and August where customers in Europe shut down for their maintenance purposes, and we do as well. It will really depend on how that startup happens and when, as Don said, we start to see the orders start to flow back in in the fourth quarter. But for now, it did not have a big impact in the second quarter, but we do expect high value product growth to be double digit for the rest of the year and for the full year.

Okay. And a then on that, how much -- or if you can maybe split the high value product growth between maybe new injectable approvals and just maybe improving volumes into your existing base, so maybe higher same store sales call it?

I think the bulk of it is higher store sales. Clearly existing products in the marketplace comprise the bulk of the increase.

We had a -- if you remember back in the first half of 2012, we had a biologic that we were a part of that was launched, and that caused part of that 28% increase in the second quarter of 2012. So you had tough comps to compare to as well.

Okay. And then just lastly, Don, on the Delivery side you mentioned in the press release the manufacturing project delays. Could you elaborate on that a little bit, please?

Actually, there are regulatory delays associated with two customers. They have been asked to provide additional data on the products they are seeking approval for. They are working on that. It is not related to us, and we are just waiting for the go-ahead.

Any visibility on how quickly those could be resolved?

Our hope is that they will be resolved before the end of the year, but I wouldn't be surprised, given the unpredictable nature of these things, if it slipped into the first quarter of next year.

All right. Thank you. Thanks for the questions and congratulations on the quarter.

Thank you very much for your questions, Dave. (Operator Instructions). Next question is from the line of Ross Taylor from CL King. Please go ahead.

Hi. Just circling back to the exclusivity agreement again. Do you think it is likely you may enter into exclusivity agreements with other partners in different therapeutic area, or is there something unusual about this particular market?

No, I think that is the nature of the beast with systems like this. If you look at what happens in auto injectors, what you typically see is exclusivity for an indication to a customer, and for other customers entering the therapeutic category you see different systems coming in. My expectation is fully is that we will see more agreements of this type in a range of therapeutic areas.

Okay. And if my memory is correct, I think on your last call you mentioned that you may -- or one of your partners may initiate a clinical trial of SmartDose later this year. Is that still the case? And I just wondered if you could say whether it is with this partner you just signed the exclusivity agreement with?

Not going to comment on the partner, but our expectation is that it will be in a clinical trial within the next two to three quarters.

Okay. And final question just relates to CZ. I don't know if there is any general comments you can make about whether any of the efforts or development timelines by some of your partners may have changed, kind of commercialization still on track with your expectations?

Everything we have is seen is that things are still on track relative to the general timelines we've talked about in the past. So no real changes there. Stability trial is ongoing. Line trial is ongoing. A lot of data being generated, but so far so good.

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

Thanks, Ross.

Thank you very much. We have one more question from the line of Arnie Ursaner. Please go ahead.

A couple of follow-up questions. One, how should we think about the accounting treatment on this agreement, the exclusivity agreement and payment that you are going to receive?

Okay. It is pretty straightforward. We have got it on the balance sheet right now, the $20 million sitting in cash. And ratably over the next 13 years, so roughly $1.5 million per year, will find its way into the income statement. And so in the second quarter of 2013 we had rough -- just under $200,000 of income relative to this. About $120,000 a month. So for the full year the eight months that we will have recording income on it will be about $1 million.

Okay. And going to the SG&A line for a second, you mentioned or highlighted increased outside service costs in connection with IT. Just remind us -- and supply chain efficiencies. Remind us how we should think of that on a go forward basis? When should that --

It is when -- a lot of the IT -- I'll answer the first one first -- the IT question is really infrastructure changes. We are going to a lot of private cloud environment architecture. Expensive stuff and the lives are generally shorter than you would think of machinery and equipment. So that -- those assets that you are put on the books end in the P&L through increased depreciation over some where between three and five years, depending on what it is.

So that is what we will expect there. And we will continue to see that, Arnie. That will continue for the rest of this year and for the next several years. The total number that you are talking about in terms of a base is somewhere between $10 million and $20 million.

On the outside service costs for our supply chain initiatives, that is a -- we are looking at our manufacturing footprint -- our global manufacturing footprint, and demands on our manufacturing platform, which are pretty great -- especially in the Packaging Systems side. So we are looking at trying to optimize that, and we are spending some money with some outside consultants to help us look through that.

Going back to -- you know you are going to get asked again more about the exclusivity thing. As part of the deal, are you committing certain manufacturing -- A, remind us how you plan to manufacture SmartDose? And B, are you committing manufacturing or a certain amount of output to this exclusive customer for the $20 million?

The manufacturing strategy currently utilizes our assets in Israel. The plan is to bring manufacturing into the United States when volumes reach a certain point. We have not dedicated specific capacity to this agreement.

Okay. Thank you.

Thanks, Arnie.

Thank you very much for your questions, ladies and gentlemen. I would now like to turn the call over to Don Morel for closing remarks. Please proceed.

Thank you very much for your time this morning, everyone. We look forward to speaking to you again on our third quarter conference call in early November.

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a good day.