西式醫藥服務 (WST) 2014 Q1 法說會逐字稿

Welcome to the West Pharmaceutical Services First Quarter 2014 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 recorded or re-broadcasted at the Company's expressed permission. Your participating 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 Westwicke Partners. Sir, you may begin.

Thank you, operator. Good morning everyone and welcome to West's First Quarter 2014 Results Conference Call. We issued our financial results this morning, and the release has been posted in the investor's 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 on the investor tab under presentation material 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 you to view the presentation, it's 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 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 the 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. Good morning everyone and welcome to West's First Quarter 2014 Earnings Call. This morning Bill and I will review our results and discuss our outlook and financial guidance for the remainder of the year. We will again refer to a slide that can support our prepared remarks that can be accessed through our website at www.westpharma.com under investors. In the even you cannot access the presentation, our commentary will cover the information both in this morning's release and the slides.

Beginning with slide number three, which summarizes our Q1 performance, a modest increase in sales coupled with the less-than-favorable mix in the packaging systems segment produced a softer start to the year than we would normally see. As we discussed in our February call, this was not completely unexpected and do not believe it reflects any fundamental change in the underlying drivers of our business.

On a consolidated basis, sales rose 1.2% to $346.8 million excluding the effects of currency. Revenues were effectively flat in the packaging systems segment while sales increased 5.6% in the delivery systems segment driven primarily by demand for contract manufacturing services. The less-than-favorable mix produced the decline in our gross margin leading to earnings of $0.38 per fully diluted share versus $0.44 in the first quarter of 2013, which was a record year in all respects.

Highlights for the operating segments is shown on slide four. For the quarter, packaging systems sales of high-valued products declined by a little over 6% primarily as the result of reduced orders through Teflon and FluroTec closures. This was built into our full-year operating plan given the substantial growth that these product lines experienced throughout 2013. Our analysis of current order flows and the rapid increase in our packaging systems backlog through March gives us confidence that this issue is largely behind us.

In the delivery systems segment, slight declines in sales of proprietary products like safety, reconstitution, and CZ were more than offset by continued strength in the contract manufacturing business. CZ sales for the period were $3 million comprised mostly of vial and cartridge sales. Sales in the 1 mL long insert-needle syringe were modest and are expected to be sporadic throughout the year depending on customer pre-commercial use for testing and validation requirements.

Despite the relatively slow start to the year, we see no fundamental changes to the primary growth drivers of our business over the long term. For the next three quarters we expect our order book to steadily improve leading to a strong finish for the year. Indeed, as I mentioned earlier, our backlog strength grew substantially at the end of the first quarter, increasing 11% versus year-end levels. More importantly, the composition of the backlog indicates that orders for high-valued products are returning to historical patterns and we should see high single to low double-digit growth through the end of the year.

Slide number five provides highlights for our ongoing expansion and development program. Our new China Elastomer plant is now operational and has started commercial sales. Work on the India seals plant has been completed and we have received our operating license from the local government authorities.

On the development program front, we continue to work closely with a number of customers to develop custom device solutions based on a broad array of less technology including SmartDose NCV. As noted in our release this morning, pursuant to a development and supply agreement, we are collaborating with Amgen on automated mini-dosing systems utilizing West's SmartDose technology. Due to the confidential nature of our work with Amgen, we will not be providing any further commentary other than what is in today's release.

The 1mL insert-needle syringe program is at a stage where orders will continue to fluctuate quarter-to-quarter as our lead customers have completed much of their qualification work. For those customers with formulations undergoing formal stability testing, we continue to believe the lead candidates for commercialization will finish testing in the late 2015 or early 2016 timeframe. Once this testing is complete, the data can then be submitted to the appropriate regulatory agency depending on the market where approval is being sought.

On a positive note, demand for CZ cartridges to support SmartDose testing and CZ vials for aggressive drugs continues to be healthy and in line with our expectations.

As summarized on slide number six, we are confirming our guidance for the full year and believe sales growth will be in the range of 6% to 8% on a consolidated basis, yielding revenues between $1.45 billion and $1.48 billion. We are forecasting an improving mix through the end of the year driven by high-valued product growth which should translate into stronger consolidated gross and operating margins yielding full-year adjusted earnings in the range of $1.77 to $1.89 at our assumed current exchange rates.

Our confidence in delivering solid sales and earnings growth for the full year is based on the positive change in order flows at the end of the quarter, the composition of our backlog, and the absence of any fundamental change in our underlying business drivers for market share.

Our strategy remains focused on expansion of our high-valued product offerings, lean operations, and selective organic growth in emerging markets for the packaging segment while shifting sales in the proprietary products group to a higher percentage of our overall sales for the PDS division. We believe proprietary products as a percent of overall sales will continue to grow through 2014.

On a final note, I'd also like to extend an invitation to attend our 2014 Investor Day on the morning of May 22, which will be held at the Cornell Club in New York City. Details will be posted on our website in the next few days. However, for those who cannot attend, the presentation will also be webcast.

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. Good morning everyone. We issued our first quarter results this morning reporting net income of $27.1 million or $0.38 per diluted share versus the $0.45 per diluted share we reported in the first quarter of 2013. As explained in the release, excluding the effect of one-time items from the prior-year quarter, our first quarter 2013 earnings were $0.44 per adjusted diluted share. A reconciliation of those non-GAAP measures is provided on slides 13 and 14.

Turning to sales, slide seven shows the components of our consolidated sales increase. Consolidated first quarter sales were $346.8 million, an increase of 1.2% over first quarter 2013 sales excluding exchange. Packaging systems sales were essentially flat versus the same quarter 2013 sales excluding exchange. Sales price increases in packaging systems were limited to approximately 0.4 percentage points and were offset by an unfavorable mix of products sold with our high-valued products declining 6.9% versus the prior-year first quarter.

The decline in high-valued product sales was not unexpected and we believe should be considered in the context of the double-digit growth experienced in each of the two last year comparable quarters benefiting from customer inventory builds. Importantly, for the remainder of 2014 we expect an 8% to 12% growth in high-valued product sales versus the comparable year period.

Our current packaging systems backlog growth of 11% over the prior year and is mostly due to an increase in committed high-valued product orders. In short, we do not believe our first quarter results represent any change in the long-term growth trajectory for our business.

Delivery systems sales increased by 5.6% or $4.9 million over sales in the prior-year quarter excluding exchange. Crystal Zenith product sales were $3 million in the current quarter, approximately $600,000 below Q1 2013 levels and were predominantly comprised of vial and cartridge samples. Overall sales of proprietary products were $21 million or 22.5% of the segment's revenues in the quarter versus 25% in the prior-year quarter.

As provided on slide eight, our consolidated gross profit margin for Q1 2013 was 30. -- for 2014 was 30.7% versus the 32.9% margin we achieved in the first quarter of 2013. Packaging systems first quarter gross margin of 35.4% was 2.3 margin points lower than the 37.7% achieved in the first quarter of 2013. The decline in the gross margin is due to the unfavorable mix from the lower HVP sales and lower plant utilization coupled with normal inflationary increases in labor and overhead costs and the relative low price increases.

Delivery systems first quarter gross margin declined by 1 margin point to 18.1% compared to the prior-year quarter. The current quarter's lower gross margin is primarily due to the decline in proprietary device sales and normal inflationary increases in labor and overhead costs.

As reflected on slide nine, Q1 2014 consolidated SG&A expense decreased by $2.7 million versus the prior-year quarter. As a percentage of sales, first quarter 2014 SG&A expense was 16.2% versus 17.4% in the first quarter of 2013.

Pension costs declined by $1.9 million benefiting from the strong returns on plan assets in 2013. Stock-based compensation and incentive costs were $1.3 million lower than a year ago primarily as a result of the decrease in our stock price during the first quarter of 2014. Other compensation costs were $2.3 million higher including annual salary increases and increased staffing. Outside service costs were lower than the prior-year quarter.

Slide ten shows our key cash flow metrics. Operating cash flow was $8.8 million for the quarter, $10 million less than the prior-year quarter reflecting the decline in our results and higher working capital requirements. Our capital spending was $31.7 million in the current quarter. We expect to spend approximately $125 million to $145 million in capital in 2014. Approximately half of the planned capital spending is dedicated to new products and expansion activities including approximately $13 million for the construction of packaging systems facilities in China and India.

Slide eleven 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 March 31 was $230 million equal to our December 2013 balance. A large majority of our cash is invested overseas and is generally not available to be repatriated to the US without incurring tax consequences.

Debt at March 31 was $404 million, $31.4 million higher than at yearend. Our net debt to total invested capital ratio at quarterend was 15.8%.

Working capital totaled $459 million at March 31, $45 million higher than at yearend. The majority of the increase is due to higher inventory and accounts receivable balances. Our backlog of committed packaging systems orders stands at $351 million at March 2014, 11% higher than at yearend excluding exchange. But as expected, about 5% lower than the March 2013 backlog, which we attribute to our shorter lead times. At March 2014 high-valued products represent 53% of the total backlog versus 49% of the December 2013 backlog.

Based on our Q1 2014 results and our analysis of the orders on hand, we have narrowed our full-year 2014 earnings guidance in this morning's release. That guidance is summarized on slide 12. We have based our guidance on an exchange rate of $1.37 per euro. By contrast, our previous guidance was translated at $1.35 per euro rate. As a reminder, each one penny weakening of the dollar versus the euro results in approximately a $0.01 increase in full-year forecasted EPS as a result of translation.

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

Thank you very much, Bill. This concludes our commentary for this morning. We will now be pleased to answer any questions. Operator?

(Operator Instructions.) The first question comes from Arnie Ursaner of CJS Securities.

Good morning. Focusing first on your backlog, your lead times had been running extraordinarily high, 22 to 24 weeks. You had brought it down to around 12 weeks in Q4. Is that about where we are now?

Yes.

Okay. In Q4 you had mentioned two additional new development agreements for -- I believe for SmartDose. Is there any update you can provide on that?

No. The work is ongoing and we are producing samples for those clients.

Okay. And then you also referred to some deferred projects that would add to your backlog in contract man -- that would add to contract manufacturing revenue. You can have some fairly sizable swings in margin depending on what these products are. Can you expand anymore on the deferred projects and when you expect the revenue from that to hit?

The first project is online as we speak. We are doing validation and trial runs on the tooling. The second one will come into operation later in the year. We expect the first to contribute a good amount during the year; the second one a bit more modestly. But both of those should be up and running fully by the third or fourth quarter.

Okay. And I do have one final question if I can? In your prepared remarks regarding guidance you talk about $10 million to $20 million in the course of the year in growth and sales and development income associated with proprietary products. Is there any change in that? I know the numbers are the same. Is there any message or change you're trying to convey with that at this point?

No. It's actually comprised of a combination of paid development agreements by the [customer] plus revenues from proprietary products.

Okay. Thank you very much.

Thank you. The next question comes from Rafael Tejada of Bank of America.

Hey. Good morning. Thank you for the questions. So just getting back to the backlog question again. I wanted to make sure I heard you right. So you said backlog was up 11% year-over-year, so that's about 416, 415 or so.

That number is up opposed to the yearned number 2013.

The yearend number was roughly around $315 million so we're at [351] now.

Okay. And so I thought it was encouraging to hear that you do have more committed orders from higher -- high-valued products. I just wanted to get a better sense of how we should think about the burn in terms of when to expect recognition for that backlog if anything's changed in terms of how you see that backlog progressing through the quarters?

Yeah. It's primarily, as you know, the backlog will be revenue generally in the next quarter plus some that falls into the succeeding two quarters after that. That has -- the curve of that has shortened. Because of our shortened lead times, customers don't need to place their orders as much in advance. So you'll see a lot of that come through in the second and the third quarters.

Okay. And also just thinking about the pacing of the year. You're reaffirming the sales growth but I'm wondering if you could give us a little bit more detail I guess in terms of how you see the sales trajectory changing -- pacing through the year? And you're reaffirming your margin outlook too, so just given what we saw in Q1, how do we see that moving through the year? Thanks.

We clearly think that we're going to see stronger performance in the second quarter. Our visibility beyond that tails into the third quarter a little bit, not so much in the fourth. What we're hearing from our customers is that those orders are going to continue to increase throughout the year, especially the ones that we highlighted in our February call where we had inventory builds for the process change in our Le Nouvion facility as well as some new product launches.

So we expect steady improvement both on the sales front and on the margin front through the end of the year. Certainly it's a bit unusual compared to our normal years where we've historically seen the front end loaded for the first six months, but this has happened to us in the past. I think it was 2009 or 2010 where we had a soft first half of the year and then it strengthened. Actually it was 2011. It strengthened through the fourth quarter of 2011 and then things really started to hit robustly.

Okay. Just a couple more. Any impact from weather this quarter? And I was wondering if you could comment just on -- I guess on the just purchase orders from pharma, spec pharma, any changes in habits from key end customers?

No. I mean the weather issue was a non-issue for us actually surprisingly. The one plant we were worried about was our Upstate pharma plant in Jersey Shore. Everything was in line with our expectations there.

On the specialty pharma front, the only change that we have really seen has been the one customer that ceased operations in 2013. They were a contract manufacturer and predominantly consumed the high-valued FluroTec and Westar closures. So those revenues are being picked up by other customers. We've seen slight increases in some and we've seen the status quo in others, but we haven't seen any single customer stand out.

The only ones that really have a strong delta are the ones that I spoke about previously that had to do the qualification runs because of the process change at our French plant and those that had strong inventory builds in the second half of the year, but we see those orders returning in the second quarter.

Okay. And this is more of a higher level question, Don, but one of the questions I'm getting is on basically the potential impact of some of the pharma consolidation, asset changes, et cetera, and basically just thinking about the way in which in the past these sort of transactions have impacted the business as it relates to inventory destocking. And so just wanted to get your perspective I guess on what you're seeing out there, any concern in the business, and I guess actions to mitigate any sort of risks that may present. And a lot of these things are so early, but just wanted to get your thoughts.

Yeah. I think the key point, Rafael, is what you said at the end. They are very early. Once they close and the consolidation plans, the merger plans begin to take effect, the principle effect on us tends to be a delay in development programs where decisions are pushed off until the organization is worked out and the various lines of decision-making are established.

The other way that we're effected is often if there is a concentration in a particular therapeutic category, the regulatory authorities may ask them to divest certain product lines. We usually see those picked up. So there can be a change in order patterns while those sales take place and the new producer picks up the product, but they tend to take place over time and very, very hard to predict.

So qualitatively one, delays in development programs and the decisions made there as to what to fund and what to prioritize, and two, the product shift that sometimes take place.

Okay. Very helpful. Thank you.

Thank you for your question. (Operator Instructions.) Our next question comes from Ross Taylor of CL King.

Hi. Just two or three quick questions. Just first a minor question on the backlog. For last year's March quarter, can you give a percentage breakdown for the high-valued product versus the more standard products just to give an additional point of reference.

It was 53% high-valued products of the total, which is what it is at the end of March this year as well. At the end of December, as I mentioned, it was down to 49% of the total.

Okay.

Yeah Ross, one comment. You have to be careful in that comparison because I would suspect the 2013 number incorporated some volume for the contract manufacturer I spoke about. So the delta is actually better on a comparative basis.

And we also had longer lead times in March of 2013, which if you're trying to do apples-to-apples, those lead times have come down, so the customers don't need to place orders as much of in front of when they want delivery as they had back in March of 2013.

Okay. All right. That's helpful. And I'm kind of guessing that that increase in the percentage of the backlog related to the high-valued products is one item that gives you a lot of confidence in that forecast you gave out of 8% to 12% growth in the high-valued products over the balance of this year. Is that assumption correct?

I think I would put it more into a family as opposed to a single product, Ross. Clearly a lot of that is FluroTec and Teflon-coated closures as well as prefilled syringe plungers. Those would be the driving categories.

But we do, you're right, the fact that the backlog is increasing and that composition of the increase is largely related to high-valued products does give us a lot of comfort that 8% to 12% growth for the remainder of the year makes sense to us in high-valued products.

Okay. That's helpful. And my last question relates to one of the comments in your press release on SmartDose where you stated that you expect some early-stage or promising early-stage work to emerge as full-scale development programs during 2014. And if something becomes a full-scale development program, does that mean it's highly likely or 100% likely that it's going to go into clinical trials or just kind of how should we think about quota full-scale development program?

A full-scale development to us means where we are delivering a solution to the customer for either their human-use trials and/or clinical trials. When it gets to the commercialization phase, it usually means that we are at the start of phase 3 and we have to have the lines and then we'll produce actual devices should the regulatory bodies approve the product that will be used when the product goes to market.

So full-scale development applies to us delivering those devices for the human-use and early clinical trials.

Okay. That's great. Thanks very much.

Thank you. Our next question comes from Arnie Ursaner of CJS Securities.

Hi. A couple of quick followups. Normally your Q1 is your peak gross margin quarter as you get the benefit from price increases. Obviously this year's gross margin was somewhat less. Again, I just want to clarify. There's nothing other than timing and mix that would have affect your gross margin outlook?

Yeah, the price -- you mentioned it, Arnie. We had in packaging systems the price increase was 0.4 percentage points. If you compare that to the first quarter of 2013, it was 2.4 percentage points.

Okay.

Yeah. If you were to normalize the quarter, Arnie, for the HVP sales that declined, I think you'd see the margin is pretty much in line with where we were in prior Q1.

That plus the pricing. And remember, Arnie, as we said in the release, normal inflationary cost increases have affected our margin as well. And those things along with when you have less high-valued products, you've got less throughput in the plants, so you're efficiency isn't as good, you're absorption isn't as good. So all of those factors together cause that margin to decline by 2.2 percentage points on a consolidated basis.

And we break out your SG&A in more detail than you do. Just to freshen that up, can you comment on your IT spend and your outlook for that for the year?

The IT spend was down, not a lot. It was roughly about the same as it was in the first quarter of last year. And our spend for the full year will be roughly equivalent to what it was last year.

Okay. And then I have a more structural question for Don, if you don't mind? There's been tremendous discussion among healthcare analysts about reimbursement and pricing on orphan drugs. I think the thing that really highlighted this was Gilead and I will mangle the pronunciation of the drug, Sovaldi. And the conclusion some investors seemed to reach is that healthcare companies were going to stop development of future drugs which would obviously have an enormous impact on you. Care to comment on that, Don?

We certainly haven't seen any signs of that. I mean obviously the total course of therapy for the Hep-C drug out of Gilead kind of hit everybody between the eyes. I mean there's no doubt that it's expensive.

But in terms of development programs we see coming in and customer inquiries on closure systems and devices for new drugs, we've seen no change. I mean clearly the conversation is going to continue because of the ACA and reimbursement but if you're the person that needs the drug, I think you're going to find a way to pay for it.

We're optimistic. We think the pipelines are as good as they've ever been. The composition of the trials coming through the FDA have a very high percentage of biologics, as you know. And that's a space where West really enjoys a comfortable technology advantage currently as well as relationships with those customers that are key. So I'm optimistic.

Thank you very much.

I would now like to turn the call over to Mr. Don Morel, Chairman and CEO, for closing remarks.

Thank you very much, operator. And thank you everyone for your time this morning. We look forward to speaking with you again with our second quarter results in the latter part of July or early August. Thank you.

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