西式醫藥服務 (WST) 2013 Q4 法說會逐字稿

Welcome to the West Pharmaceutical Services fourth quarter and full year 2013 results conference call.

(Operator Instructions)

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

And now I'd 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 fourth quarter and full year 2013 results conference call.

We issued our financial results this morning and the release has been posted in the Investors section on the Company's website located at www.westpharma.com. If you have not received a copy of this 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 a link to a free download of that -- 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 non-exclusive 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 this morning's earnings release.

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

Thank you, John; and good morning, everyone.

Joining me for today's call are Bill Federici, West's Chief Financial Officer; and Mike Anderson, our Treasurer and primary investor relations contact. This morning, Bill and I will review our fourth quarter 2013 results and discuss our outlook and financial guidance for 2014. To support our commentary, we will refer to a PowerPoint slide deck that can be accessed through our website, www.westpharma.com under Investors. In the event you cannot access the file, the information in the slides is covered in both this morning's release and our remarks.

Turning to some highlights for the fourth quarter as illustrated on slide number 3, West finished 2013 with a solid fourth quarter generating adjusted earnings of $0.38 per share versus $0.30 in the fourth quarter of 2012, an increase of more than 25%. Sales on a constant currency basis were up just over 5% at $342.7 million, and our consolidated gross margin improved by 0.8 percentage points. Sales growth was driven by a slightly more favorable product mix and price increases in Pharmaceutical Packaging and higher contract-manufacturing revenues and proprietary product sales in the Delivery Systems group.

Slide 4 provides a summary of our fourth quarter financial performance. Slide 5 provides operating highlights for both the Packaging Systems and Delivery Systems segments. For the quarter, Packaging Systems sales increased 4.5%, led by high-value Envision and FluroTec components. The backlog decreased slightly as our manufacturing team focused on reducing lead time and back orders for some key products. Sales in the Delivery Systems segment increased 7% led by increased sales of the Eris safety system and contract-manufacturing services.

Our full year financial performance is summarized on slide 6. 2013 was a record year for West. Sales grew 7.2% on a consolidated currency neutral basis to $1.37 billion, driven by high-valued product sales and strong international sales growth in Pharmaceutical Systems. Our gross margin and operating margin each improved by 1.2 and 0.7 percentage points on an adjusted basis to 31.8% and 11.9%, respectively. Adjusted earnings per share were $1.63 taking into account the two-for-one stock split executed in September.

We also increased our R&D investment in key programs like SmartDose while maintaining our capital program to build capacity for high-value products lines like Envision, FluroTec and NovaPure. Most importantly, we secured the $20 million milestone for SmartDose exclusivity with a major customer and CZ sales for the full year exceeded our initial expectations at the outset of the year driven by cartridge and vial volumes.

Our global capacity and product development projects continue to move forward as summarized on slide 7. Our China rubber facility is operational and we are integrating that new capacity into our global manufacturing planning. Installation of machinery for metal seal manufacturing in our new India facility is nearing completion and validation tests are now underway. We expect to begin commercial sales from this operation in the next few months.

We continue to evaluate the right timing for construction of the Elastomer facility based on how we see demand unfolding in emerging markets over the next six to nine months. We will continue to invest in the development of our proprietary device platforms and expect continued growth from our currently marketed systems for reconstitution in needle safety in addition to clinical trial supplies for SmartDose and CZ.

Sales of CZ containment systems totaled $17.4 million in 2013, more than twice the level of 2012. While we made good progress on a range of programs in 2013, including having two customers advance CZ systems into human clinical trials, demand will continue to fluctuate for the foreseeable future due to the uncertain timing of validation requirements and future clinical trials. We now believe there are a total of six molecules utilizing CZ primary containment systems on formal stability with the potential for four additional molecules to begin formal stability in 2014.

Two new development agreements for SmartDose were completed in the fourth quarter along with our first development program for the ConfiDose injection system. We expect the first half of 2014 to be very active for the device group with a 510(k) filing for SelfDose, SmartDose entering a large-scale human trial with the customer's drug, a potential supply agreement for the Eris safety system, and the customer-funded clinical trial for the SelfDose system.

In our contract-manufacturing group, the two programs delayed at the end of 2013 are scheduled to go into production during the first and second quarters. A third program for a new customer injection system will ramp up through the second half of the year, as well. Turning to our outlook for 2014, we see no fundamental changes to the primary growth drivers of our business.

Our backlog entering 2014 was down slightly from the prior year, largely as a result of the hard work of our operations teams to bring down lead times and back orders on certain high-value products, in addition to several customers completing some strategic and special situation inventory builds due to process change validation testing and demand for some generic injectables that were in short supply throughout 2013 returning to more normal patterns.

As summarized on slide 8, we believe sales growth for the year will be in the range of 6% to 8% on a consolidated basis building revenues in the range of $1.45 billion to $1.48 billion. However, for the reasons described above, we believe the first quarter will be softer than the record first quarter of 2013 with orders recovering in the second quarter through the end of the year.

In Pharmaceutical Systems, we believe we will see continued uptick of our high-value products like Envision, Westar, FluroTec and NovaPure, while revenue growth in Delivery Systems will benefit from new product launches for customers in our contract-manufacturing group and ongoing sales gains within our proprietary safety, reconstitution, and injection systems product lines.

We are forecasting improvement in our full year consolidated gross and operating margins, which should produce full year adjusted earnings in the range of $1.75 to $1.89 per share assuming a dollar/euro exchange rate of $1.35. 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 Systems segment while shifting our sales mix to West proprietary products in the Delivery Systems group.

We believe proprietary products as a percent of overall sales in device systems will grow to 29% from 25% in 2013. 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 fourth quarter results this morning, reporting net income of $23.6 million, or $0.33 per diluted share on a post-split basis versus the $0.30 per diluted share we reported in the fourth quarter of 2012. Excluding the effects of special items from both periods, fourth quarter 2013 earnings were $0.38 per diluted share versus the $0.30 we earned in Q4 2012. A reconciliation of these non-GAAP measures is provided on slides 15 and 16.

Turning to sales, slide 9 shows the components of our consolidated sales increase. Consolidated fourth quarter sales were $342.7 million, an increase of 5.1% over fourth quarter 2012 sales excluding exchange. Packaging Systems sales increased by $10 million, or 4.5% over same quarter 2012 sales excluding exchange. A favorable sales mix and volume growth accounted for 2.1 percentage points of the increase. Higher selling prices in Packaging Systems contributed the remainder of the increase.

High-value product sales increased 4% versus the prior year quarter excluding exchange. The slower growth of high-value products in Q4 2013 comes on the heels of a Q3 high-value product growth rate of 23% and a tough comp to the prior year of Q4, where those sales grew 17%. For the full year 2013, high-value product sales increased 9.9% versus 2012, all excluding exchange. Delivery Systems sales increased $6.6 million, or 7%, over sales in the prior year quarter excluding exchange.

The sales increase was driven by good performances in our contract-manufacturing operations and our proprietary businesses. Sales of proprietary products were $24.9 million, or 24.7% of the segment's revenue in the quarter. CZ sales and development activity were approximately $4.7 million in Q4, roughly on par with the prior year quarter. On a full year basis, total 2013 proprietary product sales grew 19% over 2012. As provided on slide 10, our consolidated gross profit margin for Q4 2013 was 31.1% versus the 30.3% margin we achieved in the fourth quarter of 2012.

Packaging Systems fourth quarter gross margin of 34.9% is 0.3 of a margin point higher than the 34.6% we achieved in the fourth quarter of 2012. The impact of higher general inflationary costs was overcome by the favorable mix of products sold, the sales price actions that took effect over the past year, and continued lean savings and efficiencies in our plant. Delivery Systems fourth quarter gross margin was 21.8%, 1.8 margin points higher than the prior year quarter. Positive sales mix and operating efficiencies more than offset increases in labor and overhead costs.

As reflected on slide 11, Q4 2013 consolidated SG&A expense increased by $1.4 million compared to the prior year quarter. The increase is due primarily to stock-based compensation expense caused by the rise of our stock price, higher estimated achievement levels on long-term performance-based share programs, and other compensation increases, all offset by decreases in our pension costs and outside service costs. As a percentage of sales, SG&A for Q4 2013 was 0.7 of a percentage point less than the prior year period.

Slide 12 shows our key cash flow metrics. Operating cash flow was $220.5 million for the full year of 2013, $33 million more than 2012 due primarily to our strong operating results. Capital additions of roughly $152 million were made in 2013, including the cash payments associated with the new corporate office and research facility.

Roughly half of the remaining capital spend was on new products and expansion efforts. We expect capital additions of between $125 million to $145 million in 2014, including approximately $20 million of costs associated with our new China and India facilities.

Slide 13 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 year end was $230 million, $68 million higher than our December 2012 balance. The majority of our cash is invested overseas and is generally not available for repatriation without tax consequences. Debt at year end was $373 million, $38 million less than at the prior year end. Our net debt to total invested capital ratio at quarter end was 13.7%, a significant improvement from the 2012 year end ratio.

Working capital totaled $414 million at year end, $118 million higher than the prior year end. The increase is primarily due to the higher cash balances mentioned above, as well as higher accounts receivable and inventory balances. Our backlog of committed PPS orders remains strong at $337 million as of December 2013, which is approximately 5% less than the December 2012 balances excluding exchange. Our reduced lead times and customer inventory management actions continued to impact our backlog and our results.

We have issued our full year 2014 guidance in this morning's release. That guidance is summarized on slide 14. Our guidance is based on an exchange rate of $1.35 per euro. Our actual 2013 results are translated at $1.33 per euro rate. The favorable exchange rate environment creates favorable earning comparisons to the prior year.

Each $0.01 change of the dollar versus the euro results in about a $0.01 change in full year EPS as a result of translation. We believe 2014 revenue growth will be in the 6% to 8% range in constant exchange rates. Our consolidated sales should be in the range of $1.45 billion to $1.48 billion at expected exchange rates. Both operating segments should generate margin expansion. We believe that our favorable long-term growth rates on sales and operating profits remain unchanged. However, as we have experienced in the past, customer inventory management activities can add a significant effect, especially on any given quarter.

We have seen the positive effects of such activities over the past several years as customers have rebuilt inventory levels, or have made advance orders in anticipation of plant closings or raw material changes. In the first quarter of 2014, we expect sales to be flat as compared to the prior year first quarter, and expect difficult first quarter comps as the following factors impact Q1. Selling price increases to customers are expected to be about half of the price increases experienced in 2013, and we expect a less favorable mix of sales.

2014 R&D expenses are expected to increase by $5 million over 2013 levels. Our 2014 effective tax rate is expected to be approximately 1 percentage point higher because the US has not yet enacted the research tax credit for 2014. We expect to incur an additional $1 million to $2 million of non-cash compensation expense associated with a change in investing of certain incentive awards, a portion of which may be excluded in arriving at our non-GAAP earnings.

Despite these challenges, we expect strong sales for the remainder of the year and expect to deliver on our full year earnings guidance of $1.75 to $1.89 per diluted share. 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?

(Operator Instructions)

Your first question comes from the line of Arnie Ursaner of CJS Securities. Please proceed.

Hi, good morning.

Good morning, Arnie.

I guess my first question is going back to your backlog. So the math should be about $330 million, or so. Can you give us a little better feel for elements within that backlog?

I know last year you had some -- certainly in Q1, you had an unusual item that you have highlighted in the call. Maybe just give us a little more color on the elements of the backlog, and why you are so confident it will restore itself in the back part of the year?

Yes, in PPS it is about $336 million. Overall, it is about $353 million. We've got a bit of an unusual circumstance in the quarter, in that the part of the PPS backlog will be pushed into the second quarter, and that is simply inventory management by two key customers that have pushed some orders out.

We also had one unique item where a process change resulted in a fairly large customer in the high-value product line actually ordering more than they would normally order to accommodate line trials to prove out the process change. So in effect, what you have got is a slightly higher percentage of the existing backlog actually being three to six months out instead of just three months out.

Okay. And then, in your prepared remarks on slide 7, you mentioned that you expect a clinical drug trial in SmartDose in the second quarter to begin. Can you comment on whether that is related to the payment you received, the exclusivity payment you received? Is it related to that product?

I would not comment on that because of our confidentiality agreement with the customer. The timing of the trial is fully up to the design and the enrollment by the customer. Our best bet right now is second quarter, it may slip into the third quarter. I think the important thing is that we have begun shipping clinical units from operations for that trial.

Okay. And the broad category of the PC SK9 inhibitors is an area where a lot of people are talking about injectables having a significant role, replacing statins that are -- a lot of companies are involved in this area, running trials, and it could have a significant impact on a company like West if a product like SmartDose were used to deliver the PC SK9 inhibitors. Can you comment any more on that thesis?

There is a lot of categories could have a dramatic impact on SmartDose. I think what is encouraging for us is, as I said in my prepared remarks, is that we have two other development agreements that we entered into in the fourth quarter. Certainly, if you talk to the industry, the opportunity to formulate differently is going to, I think, bring patch injectors of this type to the forefront over the next three to five years, especially if some of these new therapies come to market.

So we think we are in a good space. We like the combination of our technology with the CZ containment system. We think it is a unique offering, and hopefully we will be able to provide some more color as things unfold through the year.

Thank you.

Thank you, Arnie.

Next question comes from the line of Rafael Tejada of Bank of America Merrill Lynch. Please proceed.

Hi, good morning, and thank you for the question.

Good morning, Rafael.

And I just wanted to dig in a little bit more on the EPS outlook. The midpoint basically just looks a little bit lighter than what I was expecting in terms of outlook. So, basically, I just wanted to get a better sense in terms of some of the components that might be affecting the gross margin, the operating margin, and the profitability of some of the segments.

So, basically, can you discuss the expectations for growth and the standard versus the high-value packaging products in 2014? Also wondering if contract-manufacturing could be a drag to that profitability in 2014? And lastly, just wondering if you can comment on your expectations for CZ contribution this year? Thanks.

Sure. Let me start with the contract and CZ contribution, and Bill can comment on the packaging side. Contract-manufacturing should actually have a pretty good year. We are seeing the two programs that were delayed last year coming into full production sometime by probably the middle part of the second or latter part of the second quarter, so we are very encouraged by that.

We have another program we expect to be substantial coming in, in the second half of the year. So if volumes hold steady, we think that will be a good contributor.

CZ is going to be a bit lumpy, as we've talked about before. It is difficult to predict, based on demands for clinical trials and line validations. We would certainly expect revenues to be on par with this year or above. So we're looking forward to good performance in both of those areas.

Yes, and Rafael, as it relates to the margins, we do expect high-value product sales for the full year to be in the double-digit range, low-double-digit range, for the full year, despite the fact that the first quarter will be a challenge. We expect that we are going to see normal inflationary increases in costs.

I mentioned that pricing is going to be less, we are going to have less pricing to our customers than we had, about half of what we had in 2013 in 2014. You can imagine that R&D expenses will continue to increase as we continue to work on our development programs on both sides of the business, both in the Delivery Systems and in Packaging Systems. That will grow by about $5 million versus 2013.

And I mentioned that our effective tax rate, because the US has not yet enacted the research tax credit for 2014, that actually will have a 1 percentage point increase in our tax rate. We are expecting 26% versus the 25% you saw in 2013. Those are the big drivers.

Okay.

Despite the first quarter's challenges because of those very, very high comps that we had, as Don mentioned, you had some things that went into the fourth quarter and third quarter of 2013, the high-value products were -- in the third quarter were up 23% in 2013. We still think we are going to be able to grow the business nicely and end up with a 6% to 8% growth in sales for 2014.

Okay. And just a couple more, just wondering if, have you seen any changes in terms of ordering patterns from those -- from generic customers as opposed to branded drug customers?

Nothing that really stands out. The biggest issue was one of the major manufacturers announced that they were going to cease production last year. We expect that volume to go to other producers, it just hasn't shown up in our forecast yet.

Okay. And just one last clarification point for Q1, there was a commentary that Q1 sales are expected to be flat, and earnings -- are earnings also expected to be flat?

On the revenue side, I think we are comfortable with that. This is the reason we guide in years, okay?

Every once in a while we get shifts in order patterns that are difficult to predict. We are very confident in the full year number, and we will see how the order book fills out for Q1 and talk about that when we get to our call in April.

Okay, appreciate it. Thank you.

Thank you.

(Operator Instructions)

Your next question comes from the line of Ross Taylor of CL King. Please proceed.

Hi, I just have two or three questions. First, I wanted to start, I wondered if you could repeat the CZ revenue number for the full year? I missed that when you gave it out in your prepared remarks.

Yes, it was $17.4 million.

Okay, and you mentioned some additional molecules coming on formal stability trials of resin CZ. Is it still best to think that those formal stability trials take about two years? Or is there any reason for us to estimate maybe it could be shorter than that?

Yes, two years is the best rule of thumb. We should also add a safety factor in because, remember, they are going to have to run line trials to get the plastic into their operations, as well. So two years is a pretty good figure on the formal stability.

Okay, and then, you are saying that you will also bake in some additional time to get it onto their lines?

Yes, for them to run plastic through their lines and prove out the performance of the system.

Okay. All right.

Their manufacturing line, not ours.

Right, right. And my last question just relates to capital spending. I think you said about half of your expected capital spend in 2014 would be associated with some of your new products.

For how many years will kind of investments in capital or plant associated with some of these new products continue? I guess what I'm trying to figure out is kind of what to expect for the next several years, in terms of your total capital spending level?

What we see generally is, we try to put a band around it for you. Now $125 million to $145 million is a good proxy for what we'll see over time. The issue really comes down to what is in the composition of that $125 million to $145 million.

Clearly, there is an amount of normal maintenance capital, for our capital intensive business. It is about $65 million, growing as the portfolio of underlying assets grows.

We spend about $15 million, $10 million to $15 million per year on IT, as we upgrade systems and infrastructure. We will spend, as we said in the prepared remarks, somewhere in the $20 million range this year relative to China and India, probably a similar amount next year, and perhaps even into 2016 a little bit, but then that will fall off.

But at the same time, we will be continuing to put additional capacity in for our high-value products, offerings on the component side of the business. So for instance, [vision] system, additions to those, to those existing lines, manufacturing lines, as well as clean rooms to bag off the products in a clean environment.

All this growth represents a push by not only the regulators, but our customers to go toward a high quality, cleaner product. All of those things will factor into our CapEx as we go. And on the Delivery Systems side, there is a little bit of maintenance as it relates to the contract-manufacturing business, but the bulk of that spend over on that side of the business will be for the increased capacity relative to CZ, SmartDose, and the other proprietary products.

Okay, that is good. I appreciate the detail.

You are welcome.

(Operator Instructions)

At this time, there are no additional questions in the queue, and I would like to turn the call back over to Don Morel for closing remarks. Please proceed, sir.

Thank you very much, Operator, and thank you, everyone, for your time this morning. We look forward to updating you on the year when we come to our first quarter conference call in late April. Thank you very much.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a wonderful day.