西式醫藥服務 (WST) 2013 Q3 法說會逐字稿

Good day, and welcome to the West Pharmaceutical Services third-quarter 2013 results conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions) This call is being recorded on behalf of West and is copyrighted material. It cannot be re-recorded 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'd like to turn today's meeting over to Mr. John Woolford from Westwick Partners. Sir, you may begin.

Thank you, operator. Good morning, everyone, and welcome to West's third-quarter 2013 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 Westwick 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 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 US federal securities law, 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 statement. For a nonexclusive list of factors which 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 this morning's earnings release.

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

Thank you, John, and good morning, everyone. Welcome to West's third-quarter earnings call. Joining me today are Bill Federici, West's Chief Financial Officer; and Mike Anderson, our Treasurer and Primary Investor Relations Contact.

This morning, Bill and I will be discussing our operating performance for the past three months and their outlook for the remainder of the year. We will also provide a preliminary revenue guidance for 2014 and our update for our five-year planning objectives for the business. As in past calls, we will refer to a PowerPoint slide deck to support our remarks, which can be accessed via our website under 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.

West had a very strong third quarter, as summarized on slides 3 and 4. Beginning with slide 3, which shows highlights from the quarter, revenues were up strongly versus 2012, driven by high-value product sales and pharmaceutical packaging. The favorable product mix resulted in a 1 percentage point improvement in our gross margin, which, when combined with contributions from our lean initiative and SG&A control, yielded a more than 40% increase in adjusted operating profit. And as was announced in the August -- in our August call, the 2-for-1 stocks that were approved by the Board was distributed to shareholders September 26.

Turning to slide number 4, consolidated sales increased 10.9% to just over $341 million, excluding currency effects. And our consolidated gross margin increased to 30.8%. Adjusted operating profit improved by $11.8 million to $39.7 million, and adjusted earnings per share were $0.39 versus $0.26 on a split adjusted basis. Overall, it was a very strong quarter for the Company.

Additional segment details are provided on slide number 5. Sales in the Packaging System segment grew by 14.7%, and Delivery Systems grew by 1.7%, again excluding the effects of currency. Pharmaceutical Packaging sales benefited from the very positive sales mix, generated by substantially higher sales of Westar and FluroTec products, especially in markets outside the US and strong Asia-Pacific demand. Sales of high-value products increased over 23% versus the prior-year period, and rebounded from the 3.3% gain in the second quarter of this year. Delivery System sales grew modestly, driven by a 12% increase in sales of CZ cartridges and vials.

In our Contract Manufacturing operations, Europe demand continued to be strong for insulin delivery systems, while North America was softer as a result of regulatory delays with two key startup programs. We expect both of these programs to ramp up in the first half of 2014. Our current backlog of firm committed orders, as of September 30, was $355 million, on par with the backlog at the close of the second quarter, and 12% ahead of the prior-year period. On a positive note, incoming orders for 2014 are ahead of prior-year levels, a good sign for the start of the year.

Slide number 6 provides a brief summary of our ongoing expansion in new product development programs. The new China elastomer facility is up and running, with third-quarter production largely allocated to customer line trials and validation testing. Commercial sales will start this quarter. Installation of machinery for metal seal manufacturing has started in the India facility, and we expect commercial production to start on schedule in early 2014. Based on gains in production efficiency and existing facilities, however, we are looking at deferring the elastomer portion of the India facility for 12 to 18 months. This decision will be based on how we see demand unfolding for the Middle East and Far East markets over the next few quarters.

We expect double-digit increases in sales of our proprietary systems during 2013, with CZ revenues for the full year totaling nearly $15 million. During the third quarter, proprietary sales in the Delivery Systems group accounted for 24% of revenues, with CZ revenues topping $4 million. However, as we've discussed in prior calls, the nature of customer clinical trials and production validation runs will likely cause demand over the next 12 to 24 months to fluctuate. The key barometer for the eventual commercialization of CZ systems and containers remains customer initiation of formal stability trials.

We will continue to provide updates in our quarterly calls as we are able, given the confidentiality provisions of our development agreements with customers. However, interest remains very strong in CZ as a primary container, especially for sensitive biological molecules and in systems for high-volume administration, either by a prefilled syringe or pump system, such as SmartDose. I believe West is in a very strong position to satisfy the growing market need for enhanced containment and delivery systems for protein therapeutics.

Turning to our outlook for the remainder of 2013, as outlined on slide number 7 and in this morning's release, we believe sales growth for the year will be in the range of 6% to 8% on a consolidated basis, yielding revenues in the range of $1.36 million to $1.38 billion. Increased sales of our high-value product lines and the continued shift to proprietary products will drive 2014 revenue growth. We are forecasting improvement in our full-year consolidated gross margin, which, when coupled with our assumptions for SG&A and R&D spending, should produce full-year adjusted earnings in the range of $1.58 to $1.63 per share, assuming $1 euro exchange rate of $1.35 for the remainder of the year.

Slide number 8 summarizes our current outlook for 2014 and the five-year planning period ending in 2018. For 2014, we believe consolidated revenue growth will again be in the 6% to 8% range on a constant currency basis, with high-value product sales in the developed markets, volume increases in emerging markets, and new programs and contract manufacturing driving growth. As customer stability testing and validation studies continue, CZ sales within the Pharmaceutical Delivery Systems are expected to grow 15% to 20%, although off a relatively small base.

For the five-year period ending in 2018, we currently believe organic growth in packaging systems, coupled with the commercialization of new products in the Delivery Systems group, has the potential to push revenues to between $2 billion and $2.2 billion. Our fundamental strategy will remain focused on expansion of our high-value product lines, lean operations, and selective organic growth in emerging markets for the Packaging segment, while shifting our sales mix to West proprietary products in the Delivery Systems group, executing a strategy we believe has the potential to push our consolidated operating margins to between 18% and 20% at the end of the five-year plan period, consistent with the objectives we laid out in late 2012.

I'd 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 third-quarter results this morning, reporting net income of $26.8 million or $0.37 per diluted share versus the $0.21 per diluted share we reported in the third quarter of 2012. Excluding the effects of special items in both periods, our Q3 2013 adjusted diluted earnings per share are $0.39 compared to $0.26 in the prior-year quarter. The reconciliation of these non-GAAP measures are detailed on slides 15 through 17.

Turning to sales, slide 9 shows the components of our consolidated sales increase. Consolidated third-quarter sales were $341.8 million, an increase of 10.9% over third-quarter 2012 sales, excluding exchange. Packaging System sales increased by $31.8 million or 14.7% over same-quarter 2012 sales, excluding exchange. Volume increases and a favorable mix of products sold accounted for 12.3 percentage points of the increase. Sales price increases contributed to the remaining 2.4 percentage points.

Sales of our high-value products increased 23.4% versus the prior-year quarter, excluding exchange. Our Q3 2013 high-value product growth was due to continued increased demand for advanced coated and Westar process components. You may recall that our second-quarter high-value products sales grew at a more modest 3.3%. Our third-quarter sales benefited from customer inventory management actions, including the prelaunch rampup for a customer vaccine, and some safety stock building by another customer, in advance of a formulation change. We believe that our Packaging System's Q3 sales growth, excluding the effects of customer inventory management actions, is more in line with our expected annualized growth rate of 6% to 8%, and that our high-value product sales growth, excluding these items, is in the low to mid-teens.

Delivery System sales increased by 1.7% over the prior-year quarter, excluding exchange. Sales improvements for CZ and safety systems were partially offset by lower contract manufacturing sales. Sales of proprietary products were $21.3 million, or 23.6% of the segment's revenues in the quarter, compared to 21.3% in the prior-year quarter. CZ sales and development activity were approximately $4.4 million in Q3, about $2 million higher than the prior-year quarter, with CZ cartridge samples accounting for the majority of the increase.

As provided on slide 10, our consolidated gross profit margin for Q3 2013 was 30.8% versus the 29.8% margin we achieved in the third quarter of 2012. Packaging Systems' third-quarter gross margin of 35.6% is 2.3 margin points higher than the 33.3% achieved in the third quarter of 2012. The strong sales mix accounts for the majority of the improvement, aided by sales price increases and volume-related efficiency improvements in our plants that offset labor and other cost increases, while material costs were slightly favorable compared to the prior-year quarter.

Delivery Systems' third-quarter gross margin decreased 3.4 margin points versus the prior-year quarter, to 17.6%. Modest price increases were offset by an unfavorable mix of sales, due to increased sales of lower-margin CZ vials and cartridges, and lower plant throughput in the Contract Manufacturing business, together with higher material, depreciation, overhead, and labor costs.

As reflected on slide 11, Q3 2013 consolidated SG&A expenses increased by $2.4 million or 4.5% compared to the prior-year quarter, due to normal inflationary increases, personnel increases in Asia to support our growing business, and increased outside services spend, mostly related to our review of our supply chain. Within the Delivery Systems' segment, SG&A costs include additional support for business development and marketing of our proprietary product offerings. Retirement plan expenses decreased by about $1 million versus the prior-year quarter. Current-quarter SG&A expense declined as a percentage of sales compared to the prior-year period.

Slide 12 shows our key cash flow metrics. Operating cash flow was $151.7 million for the first nine months of 2013 -- $34 million more than the comparable prior-year period, due primarily to our strong operating results and receipt of the $20 million SmartDose exclusivity payment earlier this year. Capital additions of $113.1 million were made in the first nine months of 2013, including the $35 million of accrued new headquarter building costs paid in 2013, roughly half of the capital we spent on new products and expansion efforts. We expect to spend between $125 million and $135 million in capital in 2013, excluding the $35 million of accrued new headquarter building costs.

Slide 13 provides some summary balance sheet information. Our balance sheet continues to be strong, and we're confident that our business will provide necessary future liquidity. Our cash balance at September 30 was $222 million, $60 million higher than our December 2012 balance. The vast majority of our cash is invested overseas, and is generally not available to be repatriated to the US without incurring tax consequences. Debt at September 30 was $400 million. Our net debt to total invested capital ratio at quarter-end was 17.6%, about 8 percentage points lower than the prior-year end ratio.

Working capital totaled $397 million at September 30, $101 million higher than at the prior-year-end. The increase in working capital was due to the increase in cash, accounts receivable and inventories, as well as timing-related decreases in accounts payable and accruals.

In summary, we had a strong third quarter. Our full-year guidance yields consolidated sales growth of 6% to 8%, ex-currency, and should result in mid to high-teens adjusted diluted EPS growth. We also expect sales growth to continue in that 6% to 8% range, ex-currency, through 2014, and anticipate accelerating sales growth to at least that range through our five-year long-term planning horizon.

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

Thanks very much, Bill. This concludes our prepared remarks for this morning, and we look forward to answering any questions you might have. Operator?

(Operator Instructions) Arnie Ursaner, CJS Securities.

Good morning and congratulations on a very good quarter. In Pharmaceutical Delivery systems, can you help us better understand -- you mentioned lower profitability from preclinical volumes of CZ cartridges. I guess I'm thinking of it very favorably that you have a lot more CZ cartridges going out, but why would it have that negative an impact on your margins? Are you essentially giving it away at the beginning of the process?

(laughter) No, it's an item that we don't manufacture, so don't recognize the same margins off of it. Currently, it's produced by Daikyo.

And the other part of that story was the reduced throughput in the Contract Manufacturing plants, Arnie.

Okay. And then, going back to the core business, the Packaging Systems piece, you mentioned your backlog is up 12%, which is a really good number. You also had mentioned you were moving some order trends out into early next year, which seems even earlier than normal. I guess my question is, you highlighted Q3 was impacted by earlier shipments of some products and some pre-ordering for a new program. You normally have excellent visibility into all of Q4 at this point. I'm trying to weigh the two as to how much did we really borrow? And how strong a backlog do you have for Q4 entering next year?

Yes. I mean, I -- there's probably a bunch of questions in there. The orders for 2014 that are flowing in are positive and more of what we think is part of our normal business flow in the fourth quarter.

There are two things that happened in the third quarter. We did have acceleration with volumes for one vaccine product, which was not atypical, given the fact that they would be preparing for the flu season and other things. And the other one is an unusual one with a change in a detergent agent with the way that we process some of our products for a specific customer. So, in effect, during the quarter they have been double-ordering new samples so that they can run their validation trials, okay, and old samples before the product was discontinued to run current volumes. So that was the benefit that got pulled into the third quarter.

The fourth quarter is ordinarily one in which we do have good visibility, but it is subject to some lumpiness as customers adjust year-end volumes. So we feel good about where we are at and we feel good about the fact that 2014 is starting to fill in.

Okay. My final question, if I can, before jumping back in queue, is, as you obviously provide, as you always do at this time of year, your five-year plan, which drives your comp. But two questions related to that. What CapEx do you have embedded in that plan? And to the extent that some -- to the extent it's implemented, towards the end of that program, how do you see the trend of return on invested capital going?

The answer to the first question, the range is what we've seen thus far somewhere in that $120 million to $150 million. It will vary each year, but that's a good way to think about CapEx going forward.

In terms of the second question about how ROIC will progress, we think ROIC will get stronger over the planned period. As the profitability increases from the commercialization of those proprietary products in the back half of the plan, that has the -- carries not only higher revenue per unit, but also higher margin per unit in that business and, therefore, will increase the profitability and, as such, it will increase the ROIC.

Thank you very much.

Thanks, Arnie.

Ross Taylor, CL King.

Maybe I'll just start with (multiple speakers) your five-year plan objectives. The 18% to 20% margin objective, how much of that is driven by product mix? And how much of that might -- the improvement might be driven by just factors like leveraging fixed cost or a few other efficiency programs?

Yes. The majority of it is driven by the product mix, both as we see a higher shift to the value-add in the Packaging Systems group. We think that's got legs to run. A large part of it is driven by the proprietary mix in Delivery Systems moving from about 24% now to -- we think we can get it close to 50%. So, the uptake of those products carries a much higher gross margin and, in effect, drives the improvement in the consolidated operating margin.

There's not a whole lot built in on the lean and efficiency side, although we certainly will continue those programs and always look to see how we can keep our costs as low as they possibly can be. But the majority will be driven by mix.

Okay. And another question. In your remarks, you mentioned that you thought the adjusted rate of growth for your high-value Pharm Packaging items was probably in the low to mid-teens. And is that kind of a good rate to expect, say, for the next one to three years for those types of products?

Yes, I mean, Ross, we -- other than some lumpiness in individual quarters, which we saw last quarter when the high-value products only grew about 3%, we've looked back over time -- we show you that slide when we get together, the last five years through 2012, high-value products grew at 15% over -- on a compound annual growth rate over that time period. We see no reason why over -- you know, again, lumpiness in quarters, but if you look out over the year time horizons, no reason why we should not continue to see growth in kind of that low to mid-teens rate.

Okay. Thanks. And my last question relates to SmartDose. I think the anticipation had been that a clinical trial would begin with that product before the end of this year. And can you give any comments as to whether that's still the expectation?

It's likely to be pushed out to early next year. The customer has requested a few design changes, which are underway. We are doing clinical trials solely for human factors engineering. But, in terms of including the drug, it will likely be early next year.

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

Thank you.

Rafael Tejada, Bank of America.

Hey, good morning, everyone, and thank you for the questions. (multiple speakers) Just a quick question on the 2014 6% to 8% growth. Can you just talk about the growth assumptions for the different buckets? And are you still thinking of the Contract Manufacturing piece as a 3% to 5% grower? And what sort of contributions are you baking in from Crystal Zenith? Thanks.

Okay. I'll take them as you gave them. The 6% to 8% -- you think about pricing, it's going to be what we've talked about, generally, which is 1% to 1.5%. There's a little bit of volume in there, again, maybe in the same kind of vein -- 1% to 1.5%. And the rest would be what we consider to be mix. So, as it relates to the Contract Manufacturing business growth rate, yes, the 3% to 5% is a good way to think about that.

And I think I forgot your last part of that question.

The CZ contribution.

Oh, CZ is going to be, again, modestly increasing somewhere in the mid-teens rate of increase. And that will be off of base. We think this year we'll get around $15 million of sales off of CZ, and then you'll have an increase of something like 15% on top of that.

Okay. And then, with regards to Q4, could you just remind us if there was -- what sort of benefit there was from last year's flu season? And if you're factoring in -- what kind of projections are you making in terms of sales contribution this year?

Yes. You wouldn't see a whole lot for flu in the fourth quarter. That's all pre-manufactured at the end of the second and third quarters. So, year-on-year, no real change there.

Okay. And then, just a different question in regards to the sort of stocking that you're seeing from your customers, whether you've seen any changes in their stocking behavior through the year. And just bigger picture, typically, how long do biopharma customers stock -- or, excuse me; just your end customers -- how long do they stock your traditional packaging products for?

Yes. It's across the board. So if you take the disposable med device customers, that usually gets consumed in what they would consider just in time. They usually carry anywhere between four and six weeks, would be a pretty good number. Those manufacturing sites are located pretty close to there, so those times tend to be a bit lower.

On the pharmaceutical side, again, it's all over the map depending on product type and demand. It is not unusual for most companies to keep somewhere between three and four months' stock on-hand. With some of the lead-time challenges we had in the high-value products earlier in the year, we did have customers build up safety stocks to a higher level.

For the biotech companies, it's not unusual for some to be at 6 to 9 months, and others to be at 9 to 12 months. That would be for finished goods. So, we also work very closely with our customers in terms of raw materials strategies. We also have safety inventories of all critical raw materials, some of which stretch to a year.

Okay. I'll jump back in the queue. Thank you very much.

Thank you.

(Operator Instructions) Arnie Ursaner, CJ Securities.

Two follow-up questions, if I can. One is, around this time of year, you normally are dealing with contract renewals at key customers. But my recollection is, you signed most of the major ones last year, the multi-year ones. Is that correct?

That is correct. And currently, we have one pending.

Okay. And in the October 13, 2013 issue of Applied Radiation and Isotopes, they had an article discussing the benefits of CZ in a more specific closure. But you've also been trying to educate the medical community about the benefits of CZ. How do you plan to use this current study, validating the improvement from CZ to market to other companies? Or other users?

Well, it's a very unique market niche. As a reminder, the CZ platform has always had a very strong position in radioisotopes and contract imaging agents. So, Daikyo currently sells, I would estimate, probably about $30 million to $40 million worth of CZ, going directly into image contrast agents. So, the study, in effect, validated what the customer have already seen in their testing, in terms of the performance improvement of the material versus glass. The major issue there is break-resistance, but as the article pointed out, there are also some other tangential benefits.

In terms of our marketing, we continue to get the word out in terms of how we perceive the benefits for specialty high-value products to be presented to our customers, whether it's break-resistance, reduction in contamination, elimination of silicone -- all of them look for a different list of performance attributes that will enhance their product. We're fortunate to be in a position that, through a combination of technologies, we could offer them a range of those benefits. So it's conferences; it's one-on-one contacts through the sales force, and continuing to push their message.

Okay. And you've had a customer undergoing testing on -- shifting gears -- on SmartDose, you've had a client undergoing some pretty more extensive testing of that as part of a rollout. Can you update us on the status?

Yes. It's a bit of a follow-up to Ross's question. The majority of the testing that's taken place over the last six months has been very focused human factors trial. Very interested in how they obviously follow the user instruction set, placement on the abdomen, pain levels. Those trials have gone very well with very high satisfaction rates. We did get some feedback out of those trials, resulting in a couple of design changes. And that's what's pushed the actual drug trial into the early part of 2014. But we see the feedback from the patient base as being very, very positive.

Okay. Just to remind investors, Don, I know you've tried to be cautious about when we have a major inflection point on CZ, but maybe take a minute and, as you think about the kind of next five-year view, on a conservative basis, when do you expect a meaningful acceleration of West growth from CZ? When do you see that inflection point occurring?

Yes, I mean, there's two answers to the question, Arnie. One is, it follows the traditional two-year stability and one year review and approval by the various regulatory agencies. The conservative view is late 2015, early 2016. The aggressive view is a drug that would have 9 or a 12-month stability trial. We don't know of any of those going on currently, to my knowledge, which might pull it forward a little bit. But I think to put a stake in the sand, you're probably in the Q4 2015, Q1/Q2 2016 kind of range for the real inflection point.

And how many compounds currently are under review or test? I know it's been in the hundreds, but maybe (multiple speakers) --.

Yes. In terms of pre-stability and early validation and compatibility testing, we know that it's more than 100. To our knowledge -- and we have gotten no updates from our customers right now -- there are four that are on formal stability.

Okay. Thank you.

Thank you.

At this time, we have no further questions. I would now like to turn the call over to Donald Morel for closing remarks.

Thank you very much for your time this morning. We look forward to talking with you again during our February year-end call.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect and have a great day.