西式醫藥服務 (WST) 2014 Q3 法說會逐字稿

Welcome to the West Pharmaceutical Services Third Quarter 2014 Results Conference Call. At this time, all participants are in a listen-only mode. (Operator Instructions) 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'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 third quarter 2014 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've 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 Web site under Investors on the Presentation Materials tab 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, 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 U.S. 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 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 very much, John, and good morning, everyone. Welcome to West's third quarter 2014 Earnings call. Joining me on the call this morning are West's Chief Financial Officer, Bill Federici and Mike Anderson, our Treasurer and primary Investor Relations contact.

During our commentary today, Bill and I will briefly review our results for the third quarter, discuss our expectations for the remainder of 2014, provide a snapshot of our revenue outlook for 2015 and highlights from our updated five-year business plan. The PowerPoint slides we will use to support our remarks can be accessed through our website at www.westpharma.com under Investors. If for some reason you cannot access the presentation, our discussion will cover the information both in this morning's release and the slides.

As you know, on October 15, we provided an early look at our Q3 earnings. Slide number three provides a high level summary of our financial performance during the quarter. Sales increased just over 4% from $341.8 million to $355.9 million. Our gross margin was up slightly to 30.9% and our adjusted operating profit was $45.2 million, an increase of just under 14% resulting in a 1.1 percentage point increase in our operating margin versus the prior year period. The improvement in our operating margin yielded adjusted fully diluted earnings per share of $0.44 versus $0.39 in the third quarter of 2013, an improvement of 12.8%.

Slide number four summarizes some operating highlights in the two business segments. Packaging Systems sales increased modestly as a result of higher sales of Westar and Daikyo RS and RU components. From a geographic perspective, sales grew in North and South America, were essentially flat in Europe and down slightly in Asia. However, I should note that comparisons of our Q3 2013 results to Q3 2014 for the Packaging segment are clouded by the extraordinary third quarter we had in 2013, where high value product sales were up over 20% and overall sales for the segment were up over 14%. The real story for the quarter was the strong increase in proprietary product sales generated by the Delivery Systems group. Sales overall for the segment were up 14.8% excluding currency effects generated primarily by a richer mix of proprietary products including SmartDose in pre-clinical trials. Medimop reconstitution systems and CZ vials and cartridges. The increase in proprietary sales was augmented by continuing solid demand for contract manufacturing services.

Slide number five provides an update for several of our key expansion and device development programs. As previously reported, we've completed the new elastomer facility in China and the new seal facility in India, both have begun commercial operations. Earlier in October, we announced plans for our new facility in Waterford, Ireland to increase capacity for our proprietary rubber sheeting used in insulin packaging and also advanced finishing operation for high-value closure system, targeted for the rapidly growing biotech market segment. The facility will be constructed in phases, as we see demand of all with our current targets to begin commercial sheeting production in the first quarter of 2018.

We continue to make steady progress on our major device development programs. CZ production of the 1ml long syringe is booked through the early part of 2015 and we continue to see strong demand for CZ cartridges and support of our SmartDose program. Stability trials underway by various customers continued to demonstrate excellent compatibility with a range of compound. Should note that revenues during the quarter for SmartDose supporting clinical trials and customer testing exceeded $3 million.

Turning to our outlook for the remainder of 2014, the October 15 release also provided an update to our full year guidance, which is summarized on slide number, six. We currently expect sales growth for the full year to be approximately 4% excluding currency, and earnings per share to be in the range of $1.77 to $1.82, largely as a result of the strengthening of the dollar against the euro, and an increase in our forecasted tax rate as a result of selling more high-value products in higher tax regions.

As we look toward 2015, discussions with a wide range of customers lead us to conclude that the issues that impacted sales at the outset of 2014 are largely behind us, as orders have begun to pick up and our firm backlog has improved. We currently believe sales will grow in the range of 5% to 8% during 2013, excluding the effects of currency. Sales will again be driven by high-value products and sales with existing proprietary devices along with ongoing development programs utilizing CZ and SmartDose. High value product growth in the pharmaceutical packaging group is expected to range from 8% to 10% during the year.

We also completed our five-year plan review and update in late September. Taking into account changes in the macro environment, healthcare and market dynamics and what we believe to be the principal drivers of our business. The major trends we have previously highlighted are strong indicators of the growth potential of our business. First, demographics and the prevalence of product disease; second, the pipeline of complex biologics to treat diseases such as cancer, autoimmune conditions and diabetes; and finally, the growing need for ultraclean packaging and sophisticated delivery devices to optimize the containment and accurate dosing of these compounds.

Late-stage pipelines for biologics and monoclonal antibodies, in particular are very robust. During the planned period, indications are very positive that a number of new therapeutics will gain approval such as PD1 molecules for various cancer indication GLP-1 for diabetes and the emerging class of PCSK9 agents for cholesterol reduction. We are in an excellent position to capture high value products and device sales for a substantial number of these new products and deliver value to our shareholders. Indeed, virtually all of the new molecules undergoing clinical trials in these categories will utilize high-value West or Daikyo packaging system for vial and pre-filled syringe formats.

We believe revenues will fall in the range of $2.1 billion to $2.3 billion by the end of the planned period, with improvement in our operating margins between 19% and 21%. We fully anticipate revenue growth to be driven by continued uptick and expansion of the high-value product lines in pharmaceutical packaging and rapid growth in the out years of proprietary devices. This dynamic growth will require additional capital investments in 2015 and 2016 of roughly $20 million to $30 million above our previously forecasted range of approximately $125 million to $145 million per year.

As a quick summary, our performance in Q3 was solid driven by proprietary product growth. However, comparisons are difficult due to the extraordinary third quarter delivered by the Packaging Systems group in 2013. Our backlog is significantly stronger at $349 million and strong demand for CZ and SmartDose systems for clinical trials will continue. However, future demand will be dependent on customer plans and their filing timelines.

We see no changes to our fundamental long-term growth drivers. And the strong and growing pipeline of biologics within our customer base should be a very strong revenue driver. We firmly believe that our 2019 revenue and margin targets that I just discussed are achievable. The Board and management team remain firmly committed to our strategic focus on ultraclean high value packaging systems and unique delivery devices to meet the growing demand of our markets and complex biologic molecule.

I'd now like to turn the call over to Bill Federici for 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 $31 million, or $0.43 per diluted share versus $0.37 per diluted share we reported in third quarter of 2013. Excluding the effects of non-recurring items in both periods, Q3 2014 adjusted diluted earnings per share were $0.44 compared to the $0.39 in the prior year quarter. A reconciliation of those non-GAAP measures is provided on slides 14 through 16.

Turning to sales, slide eight shows the components of our consolidated sales increase. Consolidated third quarter sales were $355.9 million, an increase of 4.2% over third quarter 2013 sales excluding exchange. Packaging Systems sales were $252 million, essentially equal to those reported in the third quarter of 2013. As a reminder, last year's third quarter sales grew 14.7% and high-value products grew 23% driven by customer inventory management. It is a notable accomplishment to equal those sales in the current quarter, including high value packaging sales, which were about 1% higher than the prior year's quarter.

Delivery system sales were $104 million this quarter, an increase of $13.5 million or 14.8% over the prior year quarter excluding exchange. Growth was driven by gains in both proprietary products and contract manufacturing revenues. Proprietary product improvements, included $4.2 million more of administration system products, and $3.4 million more of SmartDose sales for customer's pre-clinical and clinical trial.

Sales of proprietary products comprised 27.4% of the segment sales in the quarter, compared to 23.6% in the prior year quarter. Contract manufacturing revenues grew $5.7 million excluding exchange, largely on higher volume from existing programs.

As provided on slide nine, our consolidated third quarter gross profit margin of 30.9%, which is slightly ahead of the 30.8% achieved in the third quarter of 2013. Packaging Systems third quarter gross margin of 35.3%, with $0.03 of a margin point lower than we achieved in the third quarter 2013. While modest sales price increases largely offset rising labor and overhead costs, our product mix was slightly less profitable than the strong prior year quarter resulting in the reduction of gross margin. Delivery Systems third quarter gross margin of 20.3%, with 2.7 margin points higher than Q3 2013 due to the favorable mix of products sold.

As reflected on slide 10, Q3 2014 consolidated SG&A expense decreased by $100,000 versus the prior year quarter. As a percentage of sales, third quarter 2014 SG&A expense was 15.7% versus 16.4% in the third quarter of '13. Lower incentive compensation and pension costs accounted for the majority of the decrease in SG&A.

Slide 11 shows our key cash flow metrics. Operating cash flow was $136.9 million in the current year-to-date period, $14.8 million less in the comparable prior year period, during which we received the $20 million licensing payment for SmartDose.

Our capital spending was $84.8 million for the first nine-months of 2014. We expect to spend approximately $125 million to $145 million in capital during 2014. Approximately half of our planned capital spending is dedicated to new products and expansion initiatives, including the initial capital to establish the pharmaceutical component manufacturing plant in Waterford, Ireland.

Slide 12 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 $246.8 million, an increase of $16.8 million over the December 2013 balance. A large majority of our cash is invested overseas and it's generally not available to be repatriated to the U.S. without incurring net tax consequences. However, earlier this year we repatriated approximately $28 million of offshore cash, which we'd use to pay down debt.

Debt at September 30 was $342.7 million, approximately $31 million lower than at year-end. Our net debt to total invested capital ratio at quarter end was 9%, as compared to 13.7% at the end of 2013. Working capital totaled $437 million at September 30, $23 million higher than at year-end. The majority of the increase is due to higher inventory and accounts receivable balances. Receivables and inventory turnover metrics are relatively consistent with prior periods.

Our backlog of committed Packaging Systems orders stands at $349 million at September 30, above both year-end and prior September level. The composition of our backlog remains strong with high value products, representing approximately 45% of the orders, an increase of 2% over prior September's backlog percentage. Based on our year-to-date results and our analysis of the orders on hand, we have updated our full year 2014 financial guidance in this morning's release. That guidance is summarized on slide 13.

As we previously announced, our current guidance has been narrowed to $1.77 to $1.82 per share. The major factor reducing the top end of the guidance range is the decline in the value of the euro versus the U.S. dollar. Our previous guidance was based on $1.37 per euro rate, current guidance uses the market rate of $1.27 per euro. That change reduced earnings per share estimates by $0.04. Additionally, we have raised our effective tax rate assumption by one point to 27%.

As outlined in this morning's release, our Board approved a share repurchase program, which allows us to buyback up to $100 million of our common stock in open market or privately negotiated transaction and is expected to be completed by December 31, 2015. We expect the repurchase program will be funded with existing debt capacity and cash that's available.

I'd 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, sir. (Operator Instructions) Arnie Ursaner, CJS Securities.

Hi, good morning.

Good morning, Arnie.

Couple of questions. My first question is regarding your Q4 view on high-end packaging being relatively flat. Should we assume it's primarily due to the fact that dropped against another extremely difficult comp and not signaling any change in the underlying business?

No. I think what you're going to see is the usual, end of the year stuff with our customers in terms of ordering and delivery patterns. We're doing a little bit conservative. Q4 really was a slightly weaker quarter in 2013 for HVP's in the third quarter. So we started to see the downtrend at that point. And as a reminder, that's when the orders started to decline as a result of the detergent change in our process in Europe.

We -- Arnie actually, to correct you a little bit. The Q4 growth we expect, where highlight products will be greater than what it was in 2013. 2013 as Don mentioned started with -- we started to see the effects of customers working down their inventory balances. So actually the comp to last year's fourth quarter is not nearly as tough for high-value products. We expect about a 4.7% increase over that. And as we said the backlog, if you look at it, as of September, the composition of high-value products in the backlog has actually increased by 2 percentage points from September 2013 to 45%?

The next question is in your pharma packaging systems. Margin in the quarter was lower than we have modeled. And in your prepared remarks, you highlighted increased sales of the disposable medical device components. When you presented your slide with the various balls or areas showing margin, that's the piece that's in the very lower left, that's the high volume, but [lowers] margin business, is that correct?

It's the combination of those two. It's the standard product and the lower profit disposable medical device component. Those two are actually up in the quarter.

Okay. And going back to this capital spending increase relative to, let's say your five-year plan. Can you kind of walk us through the thought process on why the spending -- the incremental spending is going to be pretty significant for the next few years, but yet your views really don't accelerate till kind of 17, 18, 19. Is it that much of a lead-time you need to have to build this out and maybe be more specific what is leading you to decide, you need to increase it?

There's really two answers to the question, Arnie. So the first one on the pharmaceutical packaging side is that, as you know we produced this specialized sheeting for insulin cartridges and we only have a single facility that produces that material. So this is simultaneously a risk mitigation step for the major customers we serve, but also to support growth we see in that marketplace to that five-year period. So the first part of the facility in Ireland will be a sheeting facility.

We expect to build that out in the latter years as we see this cleanliness requirement increasing and the focus on the very high-margin, high-value products going into the biologics segment. Ireland is an ideal location for us because of increase in investment by our customer base. When you look at the biologics production capability within that area, it has increased substantially and will increase in the future as we see more compounds come out. So much of it is aimed at high margin, high-growth areas of diabetes and biologics.

The second is that we are currently producing commercially the SmartDose system in Israel. And part of that capital is to begin to split out commercial production in Arizona as we're seeing requirements, not only for CZ, but for the SmartDose devices ramp-up. We would like to have dual source of supply there for risk mitigation. So the reasons are all good. Their growth and yes, we have to invest that for ahead of the curve for validation, equipment delivery and all the reasons we've talked about in the past.

Okay. And violating my only ask two question rules, but I want to ask one more real quick, you are tied to the price of Brent crude more than most companies which are West Texas. We've obviously seen a very dramatic lowering of oil prices. How should we think about that as you go to your year-end negotiations with your customers and maybe remind everyone for lag before you have it impacting your cost or your contract price?

That's exactly right, Arnie. We have -- I'll answer the last part first. We have about a three-months lag between when the actual price of Brent declines and when we start to see it come through in our purchases and then approximately a two-month lag between when we get it into our inventory and when we actually end up selling it and therefore end up in our income statement. So it's about somewhere between four and six months sort of the lag. The sharp decline that you're talking about is really not as dramatic as some of the ones that we've seen in the past. If you go back to 2011, you'll remember that we went -- Brent went from about $65, $70 a barrel up to over $130 if I remember correctly, during that first half of the year and then came down in the back half of the year.

So, yeah, with the decline we should expect to see lower and we saw it in the third quarter, we saw that our raw material costs were essentially flat to the prior year. You'll see a little bit lower cost coming through starting in some time in 2015, probably the latter part in the first quarter. But as you're suggesting about half of our Packaging Systems sales are under contract with our customers. And those contracts generally carry a CPI or PPI accelerator in them. So obviously, we would see lower ability to increase prices.

All that said, when we look at 2015 and you have to come to the guidance that we gave you on the sales. We have not included a large increase for pricing. I believe we're about half a percent which would be below the five-year average and certainly way below the 2.5 or so that we received in 2012, 2013 timeframes.

Thank you very much.

You are welcome.

Thanks, Arnie.

Rafael Tejada, Bank of America Merrill Lynch.

Hi, good morning and thank you for the questions.

Good morning, Rafael.

Good morning. Just on the 2015 outlook on the constant currency growth, how should we think about the growth in packaging versus delivery?

Yeah, basically, it's going to be in the Packaging Systems side, high-value products driving the bulk of their growth. So we expect high-value products will grow nicely in that 8% to 10% range as Don described. We'll see the passive -- less growth coming from the standard and disposable medical devices side of that business. For the Delivery Systems side, we see very solid growth in the proprietary delivery systems that should be up solid double digits, somewhere in the 15% to 20% range. And as you can imagine for contract manufacturing, we'd expect something in the order of mid singles as a growth rate.

Okay. So I guess if I were to net that out I mean packaging probably somewhere in -- as a whole in the mid-single digits and Delivery Systems somewhere at lower -- low double digits?

Correct. On the Delivery Systems you're going to be less than a little bit double digits because you had, remember this is only the proprietary systems that's only about 27% of the total.

Okay. And we covered one of the trends in terms of fluctuating raw material prices, but also wanted to talk about infectious diseases. I'm just wondering what -- weather you're already -- there is some data that is suggesting potential stronger flu season this year, so just wondering if there is any -- if you've seeing any orders coming in? And secondly, just anything on in terms of potential tailwinds from trial activity as it relates to Ebola?

Yeah, on the first question, I think the answer is no. I mean much of the flu stocks of course are produced in advance of the season. So those numbers have already been reflected in our sales. With regard to Ebola, specifically remember the trials often are relatively small volumes. And people are -- I think in many respects playing catch up, so even if you have a 5,000 patient trial, it's not going to drive the needle. Those are very, very small volumes. The answer is yes, we are on some of the vaccines that are in development, but you're not going to see that driving the numbers.

Okay. And just a couple other housekeeping items on -- we've seen the fluctuations in currency, just wondering what's baked in terms of headwind for sales and EPS for Q4 and if you can talk about potential expectations for 2015?

Well, I'll start with the end first. As we said the number we quoted the 5% to 8% for 2015, imaged an ex-currency number. So I hopefully -- hope you can draw whatever conclusions you want. On the fourth quarter, we've used $127 to the euro, which is not what it is. This morning of course, I think Don was around that, pretty close to what we believe the market is for the quarter.

Okay. But to think of a potential 2% headwind on the top line for Q4, that wouldn't be a pretty number to use just to make sure there?

Yeah, I don't think that that's an unreasonable expectation.

Okay.

Especially versus -- Rafael just let me finish. With the full-year guidance that we took down are now in the range $0.04 that is due to currency. Some of that's in the third quarter, some of it's in the fourth. So that gives you a gauge to put on in the [third] quarter.

Great. And with the share repurchase being planned and how should we think about the deployment of that plan and I guess, what's the expectations for share count for 2014, and then just finally, just tax rate, we saw that pick up, just wondering if we should be using that sort of similar rate for 2015?

The tax rate is, what we're believing is, somewhere in that we'll end the year somewhere in that 27% range, maybe a little higher, if we don't get the R&D extender bill passed as an impact on all manufacturers. And going forward, if you are using again -- if they have the extender bill passed, 27% would not be an unreasonable expectation going forward. On the share count, we do have an increase planned about 0.5 million shares in the count, but the exact way that the share buyback program will hedge is really depending on from time to time, we'll go into the market when we see the opportunity to go in and buy.

Okay, that's helpful. Thank you very much.

Thanks, Rafael.

Thank you. Sir, you have no further questions at this time. (Operator Instructions) Dana Walker, Kalmar Investments.

Hello, there. Good morning.

Good morning.

Don, talk about zero defect, tell us that a step function above what your customers have been focusing on HPP front and how does that change the product and/or service that you're in a position to provide?

We and all of our customers were seeing a great deal of, what I would call, incentives from the regulatory bodies to look at the entire production process in terms of continuous improvement and those detection capabilities get better and better. When you inspect at the end of the line, you are seeing more and more things. So, we look at that clearly as an opportunity and for us, it is a differentiator and again, it is driving a lot of the investment that will happen in Ireland in the second phase of that building. But as a service offering, it really comes back to the attributes that we have tried to put into the closures from Westar evolving all the way through the current version of NovaPure. Each one of those attributes gives us the opportunity to capture some value from what our customers ordinarily would have provided in their own production processes than prior year. So we don't think those pressures are going to relent, indeed it's going to put pressure on the industry to meet what is a rapidly increasing quality standard. So it's an opportunity and a challenge all in the same nut.

Understood. Bill, as you update your revenue guidance, how much of that would you attribute to currency and how much of that would you attribute to something else?

We had absolutely ignored currency in the growth that we gave you, the 5% to 8%. Again is a currency-neutral number.

Talk about Q4.

Q4, we had between, somewhere around $0.02 is what we're expecting versus what we had previously guided you to. And it's $0.04 for the back half of the year between when we give you guidance on July 30 or whenever it was versus the $1.27 we're giving you now. So roughly half of that will be, what's impacting the fourth quarter.

I'm sorry, I should have been much more specific, I was focused solely on the top line?

Top line, the amount that it impacts it?

Well, you brought your revenue guidance down moderately for PPS. How of that is currency, how much that would be something else?

Okay. In terms of -- almost all of it is currency and there is some, obviously there is some impacts from the business from looking at the backlog and where we ended the third quarter, but a good chunk of that is due to currency.

The committed backlog number that you provided, can you just quickly update us as to what the comparable numbers might have been earlier in the year and a year ago at this time?

Absolute, if you look at the backlog at this year and at the end of September, it was $349 million. Now we have currency impacts impacting the comparisons, but I'll give you the currency neutral numbers. Q3 2013 was $325 million rough numbers and December 2013 was $315 million rough numbers.

Now in those numbers of disclosure, there is a blanket order from one of our major customers that impacts the comparability. So that's why, when we gave you the $349 million, we don't know exactly, we can pull out exactly how much of that is in excess of what we had at the end of September of 2013 or December of 2013, but it does impact comparability. So instead of being -- for instance up 14% versus December, no it's something less than that, it's probably on the order of mid-to-high singles.

One last question, Don, you mentioned three new biologic categories that are appearing in the rearview mirror of -- for that matter in the windshield, can you describe, timing wise, when you would expect to see product flows from there and thus demand for your products?

Yeah, I'd categorize it really as two new, one existing. So the GLP-1 has been in the market for a while, but we're seeing some new molecules coming out in a diabetes category hence new indications, several of them I believe have gotten approval as the weight loss indication in addition to sugar level reduction. The PD-1 is a new molecule for cancer, I believe that those will roll out probably over the next two to three years. We know that several of our customers -- one customer that has an approval already in the market for lung cancer, but you will see sequentially approval for different types of cancer as they complete the clinical trials and do a rolling submissions to each one of those. There were several other PD-1s that are in the application phase have not received the approval yet, but we think that's going to be a very, very strong category because of the uniqueness of these molecules and again we are virtually on all of the packaging for those both vial and syringe format.

The final , the category PCSK9 molecules are completely new in terms of cholesterol reduction. Again, we are on the primary packaging for that. We have to see how the device equation evolves, but each one of those categories, we believe, presents not only primary packaging but potentially downstream device opportunities.

As you've seen the GLP-1's rollout, has that proven to be incremental demand or higher value demand for you or does it display something?

It's really hard to say. For us, it's been incremental up demand, especially in devices where we contract manufacture, it's difficult to call out the impact on the primary packaging side. We're not sure what goes to GLP-1 versus the insulin.

Okay. I had one last question, it's awaited for the moment. So, I'll let go. Thanks.

Thank you.

Gentlemen, there are no further questions for you at the moment.

Thank you very much for your time everyone. We look forward to speaking with you again in February with our year-end call.

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