西式醫藥服務 (WST) 2014 Q4 法說會逐字稿

Welcome to the West Pharmaceutical Services fourth quarter and full year 2014 results conference call. (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 would like to turn today's meeting over to Mr. John Woolford from Westwicke partners. Sir, you may begin

Thank you. (inaudible - background noise) Good morning, everyone and welcome to West's fourth quarter and full year 2014 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 Westwicke Partners at 443-213-0500 and a copy will be sent to you immediately. Posted on the Company's website under Investors in 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 it, 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 U.S. Federal securities law and that are based on management's beliefs and assumptions, current expectations, estimates, and forecast the. Many of the factors that will determine the Company's future results are beyond the ability of the Company to control or predict. These statements are subject to known or unknown risks or uncertainties and therefore actual results could differ materially from past results, and those expressed or implied in any forward-looking statements.

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

Thank you very much, John, and good morning, everyone. Welcome to West's 2014 year end earnings call. Joining me for the call today are West's Chief Financial Officer, Bill Federici and Mike Anderson, our Treasurer and primary Investor Relations contact. In our prepared remarks, Bill and I will briefly review our results for the first quarter, look back on our accomplishments for 2014, and discuss our outlook for 2015. During our commentary, we will once again refer to a PowerPoint slide deck which 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. Let me begin with slide three which provides a high level summary of our fourth quarter results.

Although 2014 started slower than expected as a result of inventory adjustments by several European customers, and weakness in certain generic accounts, West finished the year on a strong note with demand improving across virtually all key product lines. For the quarter, sales increased to $349.8 million or just over 7% excluding the effects of currency, and the Q3 2014 disposition of a small tooling operation in Europe. Our gross margin was up slightly to 31.4%, and our adjusted operating profit was $44.6 million, an increase of approximately 29% in constant exchange rates. The improvement in our operating profit yielded adjusted fully diluted earnings per share of $0.45 versus $0.38 in the fourth quarter of 2014.

Slide number four lists operating highlights for the two business segments. Revenue growth in Packaging Systems benefited from stronger sales in North America, South America, and Europe increasing 7.7% versus a year ago. High value product sales grew just over 12% driven by Westar and Daikyo RSV. The favorable product mix, pricing, and operating efficiencies lifted the segment's gross margin by 1.3 margin points. These factors combined with prudent SG&A and R&D spending generated a $8.9 million increase in operating profit during the fourth quarter. In the Delivery Systems group, sales were up just over 1%, which translates to over 6% when the effects of currency and the interim business disposition are removed.

Gross margin in this business suffered a bit from some shifting of costs from R&D to cost of sales as projects begin to generate revenue. This contributed to the 14% increase in proprietary product sales in the quarter but also slightly lowered margins associated with some of those revenues at this stage of their development. Overall, the PDS group continued to make measurable progress against our long-term objectives with the costs of those efforts muted by growth in administration systems and good performance from our contract manufacturing business.

For the full year, as outlined in our release, sales grew to just over $1.4 billion or 4.3% excluding currency, and adjusted diluted earnings per share increased to $1.78, a year-over-year increase of just over 9%. And our third consecutive year of record sales and earnings. Slide number five provides an update for several of our key expansion and device development programs. Our new facility in India expands our metal field production capacity and with more than 20 customers qualified in placing production orders, is well ahead of plan and should turn profitable by early 2016.

As production shifts to this plant, our operations team in Asia will be converting the old [steel] production space in our Singapore facility to high value product production to meet future demands in the growing Asia market. In our third quarter call, we also announced plans for a new facility in Waterford, Ireland to meet anticipated future demand for our proprietary insulin packaging systems, and advanced finishing operations for high value closure systems. Site preparation will be completed by the end of the quarter and we expect to complete all necessary permitting and begin construction in the next few months.

In addition, we are adding high value product capacity by converting our Kingston, North Carolina facility which is historically produced lower margin components for single use devices such as syringes. The transfer of that work and the addition of a capabilities has been in process now for several years and we expect that to come online in the second half of 2015. With regard to high value products, we introduced the NovaPure product line in 2012, and since that time have been working with a number of customers to facilitate qualification and validation for use on existing products.

We have also been expanding the number of components we offer under the NovaPure brand and have recently received our first commercial orders. While it will not be a major revenue contributor in the near term, the NovaPure line represents the next generation of West closures that address the market need for ultra clean high quality products. Turning to the Delivery Systems group, 2014 was a year of significant progress across the portfolio of proprietary device development programs currently underway. Demand for the [Wynell] long CZ insert needle syringe strengthened during the latter half of the year primarily for stability testing and line trials.

More importantly at the end of 2014, the number of molecules undergoing formal stability testing has more than doubled from the beginning of the year. A total of eight customer-funded development programs based on the SmartDose platform are now underway for a range of therapeutic applications requiring high dose volumes. Give the expanding CZ cartridge demand we are experiencing we're installing additional capacity at our Scottsdale, Arizona device facility to augment the Daikyo line in Japan. We are also accelerating plans to add back-up capacity for manufacture and assembly of the device in Arizona to provide added assurance of our ability to satisfy anticipated increased demand for the device.

For the year and across all programs and customers, West is has now delivered more than 100,000 devices and an excess of nearly 800,000 CZ cartridges for a range of pre-clinical, clinical, and stability testing, and the device has been used in own 1,500 subjects in user studies and clinical trials. As we look at 2015, our order book is solidified and our firm backlog has grown 15% in constant currency versus a year ago. The timing and composition of the backlog are important factors in our expectation that sales for the full year will grow in the range of 6% to 8% excluding the effects of currency.

Sales will again be driven by high value products for high value biologics, rising sales of proprietary device, and requirements for ongoing development programming utilizing CZ and SmartDose. Ex-currency high value product sales group in the Pharmaceutical Packaging group is expected to be in the high single to low double-digit range versus 2014. Although the underlying organic growth of the business is healthy, our full year sales and earnings will be subject to the currency headwinds and the strong US dollar.

For the full year in 2014, the Euro dollar exchange rate averaged $1.33 whereas at the outset of 2015, that rate has been as low as $1.11 and is near the lower end of that range today. Assuming an exchange rate of $1.15 for the remainder of the year, currency translation would be expected to reduce sales by approximately $80 million and EPS by $0.18 to $0.20 per share. On that basis, we estimate our 2015 adjusted earnings of $1.74 to $1.92 per fully diluted share.

However for the longer term, the major trends we have previously highlighted remain strong indicators of the growth potential of our business. Late stage pipelines for biologics and monoclonal antibodies in particular are very robust. During 2014, the first approvals were granted for PD1 molecules for various cancer indications. Throughout 2015, we expect a number of new biologic approvals including the emerging class of PCSK9 agents for cholesterol reduction. There's also the potential for the first U.S. biosimilar to be approved under the new pathway.

We are in an excellent position to capture high value product and device sales for a substantial number of these new products. Indeed virtually all of these new molecules undergoing clinical trials in these categories will utilize high value West or Daikyo packaging systems for vial and pre-filled syringe formats. Regarding the CEO succession plan that we announced late last year, the search process is well underway and the Board is vetting a very strong candidate list. I have committed to the board that I will continue to serve in my current role until my successor is in place and the transition is completed. 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. Excluding the effects of special items from both periods, fourth quarter 2014 earnings were $0.45 per diluted share versus the $0.38 we earned in Q4 2013. A reconciliation of these non-GAAP measures is provided on slides 13 and 14. Turning to the sales, slide seven shows the components of our consolidated sales increase.

Consolidated fourth quarter sales were $349.8 million, an increase of 7.4% over fourth quarter 2013 sales excluding exchange and the disposition of a small business. Packaging System sales increased by $18.5 million, or 7.7% over same quarter 2013 sales excluding exchange. A favorable sales mix and volume growth accounted for 6.8 percentage points of the increase. Modestly higher selling prices in Packaging Systems contributed the remainder of the increase. High value product sales increased 12.1% versus the prior year quarter excluding exchange.

For the full year, 2014 high value product sales increased 3.5% versus 2013 excluding exchange. Delivery Systems sales increased $3 million or 2.9% over sales in the prior year quarter excluding exchange effects. The sales increase was driven by our proprietary businesses. Sales of proprietary products increased 14.2% to $28.6 million or 27.4% of the segment's revenues in the quarter. CZ sales and development activity were approximately $4 million and SmartDose sample sales were $3.5 million in Q4. On a full-year basis, total 2014 proprietary product sales grew 13.6% over 2013.

As provided on slide eight, our consolidated gross profit margin for Q4 2014 was 31.4% versus the 31.1% margin we achieved in the first quarter of 2013. Packaging Systems fourth quarter gross margin of 36.2% is 1.3 margin points higher than the 34.9% achieved in the fourth quarter of 2013. The favorable mix and volume of products sold, modest sales price increases and continued lead savings and plant efficiencies more than offset the impact of higher general inflationary costs. Delivery Systems fourth quarter gross margin was 19.6%. 2.2 margin points lower than the prior year quarter. The lower margin was mainly due to new capacity costs and the costs associated with development projects moving to clinical production and customer-funded development programs.

As reflected on slide nine, Q4 2014 consolidated SG&A expense decreased by $1.2 million compared to the prior year quarter. The decrease is due primarily to lower estimated achievement levels on incentive comp programs, decreases in our pension costs, and lower travel and entertainment costs. As a percentage of sales, Q4 2014 SG&A expense was 0.7 of a percentage point less than the prior year period. Slide 10 shows our key cash flow metrics.

Operating cash flow was $183 million for the full year of 2014. $38 million less than 2013 due primarily to the $18 million of voluntary pension contribution we made in 2014, and the $20 million non-refundable customer payment received in 2013 for SmartDose. Capital additions of roughly $112 million were made in 2014, roughly half of the spend was our new products and expansion efforts. We expect capital additions of between $150 and $175 million in 2015, including approximately $35 million of costs associated with the new Ireland facility.

Slide 11 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 year end was $255 million, $25 million higher than our December 13 balance. The majority of our cash is invested overseas and is generally not available for repatriation without tax consequences. However, we repatriated $60 million of overseas cash during Q4, a portion of which was contributed to our pension plan, and a portion was used to pay down debt. Debt at year end was $337 million, $37 million less than the prior year end.

Our net debt to total invested capital ratio at year end was $7.8%, a significant improvement from 2013's year end ratio. Working capital totalled $407 million at year end, $7 million less than the prior year end. Our high cash balances were partially offset by the reclassification to short term of our $25 million series B floating rate debt maturing in 2015. Our backlog of committed PPS orders remains strong at $340 millions as of December 2014, approximately 15% higher than the 2013 balances, excluding exchange. The high value portion of our current order backlog continues to increase versus the prior year.

We have issued our full year 2015 guidance in this morning's release. That guidance is summarized on slide 12. Our guidance is based on an exchange rate of $1.15 per Euro. Our actual 2014 results are translated at $1.33 per Euro rate. Each one penny strengthening of the dollar versus the Euro results in about a $0.01 reduction in full year EPS as a result of translation. As a reminder, most of our exposure to currency is translation risk and the majority of our non-US operations are naturally hedged.

In the first quarter of 2015, we expect sales to increase 5% to 7% ex-currency as compared to the prior year first quarter which was adversely impacted by customer inventory management. As a result, we expect Q1 2015 earnings to increase by 15% to 25% ex-currency versus the prior year quarter. The currency impact in Q1 2015 is expected to be larger than any other quarter as Q1 2014 average dollar per Euro exchange rate was $1.37 per Euro, the highest of any of the 2014 quarters. We expect to deliver on our full year earnings guidance of $1.74 to $1.92 per diluted share, which on a constant currency basis represents an increase of between 9% and 19% in diluted the EPS over 2014. I would now like to turn the call back over to Don Morel. Don?

Thanks very much, Bill. This concludes our prepared remarks for this morning. We would now be pleased to answer any questions. Operator?

Thank you. (Operator Instructions) Your first question comes from Larry Solow from CJS Securities. Please go ahead.

Hi, good morning guys. Just a couple of quick questions. (multiple speakers) You had some pretty nice growth in your higher value products especially in the quarter and even for the year. Just in terms of gross margin, I know it did go up a little bit but I thought maybe the lift would be even a little higher. Were there other factors that held it back a little bit?

No, it's just the composition of the HVP growth. A large part of it was commercialization of the Daikyo RVS line. That's produced in Japan and we serve as their agent so we don't capture as much margin off of that

Okay. Just in terms of the marketplace competitive pressures and what not. There's been a lot of chatter or some chatter on the competitive front, OmniPod from Unilife and Ultra Stelmi. I think they recently introduced a new coded stopper. Maybe you could take the opportunity to discuss a couple of these things

Well, the competitive landscape continuously shifts. The OmniPod is a unique device that is being used by one customer that has very unique time release requirement within that system. And they began work on that a number of years ago. It doesn't directly compete in many applications with the SmartDose where we want the high volume delivery over a lengthy period of time. With regard to competitors in the coded closure market, you know, our position there is well-known.

Our brands are well-established. I believe that the product that was introduced is only on serum closures so it's a somewhat limited niche in the marketplace. But I continue to like our position there and I like all of the new product iterations that we've been introducing including NovaPure so we're in a good position.

Great. Thanks, Don. Appreciate it.

Thanks, Larry.

Thanks. (Operator Instructions) Your next question comes from Rafael Tejada from Bank of America. Please go ahead

Hi, good morning and thanks for the question.

Good morning, Rafael.

Just wanted to dig in a little bit more on the guidance for the full year and for Q1. Left me start off with the full year. So it looks like you're raising the constant currency outlook just slightly. Previously it was 528. Now upper end it's 628. Is that mainly driven on where the backlog levels stand today or any other -- or any other indicators that are providing you with greater confidence on the guide?

I think it's a combination of things. One, we like the composition and the trending of the orders in the backlog. So we're going to see a uplift on the HVP side of the business we believe throughout the year. Second thing is that we've gotten a little more confidence in some of the orders that were doubly done in 2013/2014 that impacted us, coming back and returning to a more normal pattern. We also have the unpredictable nature of some of the product launches that we expect to happen throughout the year. But I think conservatively we expect that will also give us a slight uptick.

That's helpful. And with regard to Q1, if I remember correctly, that's when the Company in 2014 experienced the -- a bigger hit from the inventory management. The year-over-year comparison is 1% -- for Q1 in 2014 it was 1%. And it's probably the easiest year-over-year comparison. So what's baked then into the 2015 Q1 5% to 7% constant currency growth? The is that just a slower rollout of -- you know, is there any inventory management issues here or is it just the pacing of the year?

It is a little bit of the pacing of the year. But you remember and you started to hit on it in the first quarter of 2014, our high value product growth was very much impacted by inventory management that had happened at the back end of 2013. So high value products were down 7% in the first quarter of 2014. So you're going to see again, a more natural, we think, progression of sales growth in 2015, and we expect to see return to more normalized growth in high value products for 2015.

And as a reminder, I mentioned it in my script but I'll mention it again. In terms of currency headwinds, the currency headwind in the first quarter of 2015 will be pretty dramatic versus Q1 2014. The average exchange rate in 2014's first quarter was $1.37 and right now obviously we are talking about using a rate of $1.15.

Understood. Okay. And that kind of goes into my next questions. And just given all the moving parts, right? In terms of the changes that affects volatility along with lower oil prices. So how do we think about the margin expansion for the -- you know, how do we think about the margin expansion for 2015?

You're going to have, you know, again we think good high value product growth will translate into a favorable mix. We believe that we will have some favorability in the oil prices as you're suggesting. We think that there is some, you know, we think general inflationary costs will be, you know, about where we expect them to be, relatively tame. We're going to get a little bit of price we believe somewhere around the order of less than 1%. So when you factor all of those things in and the continuation of our lean programs, we believe that we should be able to see margin expansion in both sides of the business, both in the Packaging business and the Delivery Systems business.

Okay. And just one housekeeping. What tax rate are you assuming for 2015?

We are using 27% overall but in the first half of the year, since the have not enacted the R&D tax credit again for 2015, it picks up about a half a percent for the first half of the year.

Okay. I do appreciate the update on the CEO search. Just Don, is it timing, shall we still be expecting a transition by May of this year?

That's process dependent, Rafael. The Board is making good progress but as you can appreciate, with some of the individuals involved, there may be special circumstances that push things out a bit. I think the important thing is that for continuity, I will be here until we're all comfortable the transition will be a smooth one.

Okay. Appreciate it. Thank you very much.

Thanks, Rafael.

Thanks, Rafael

Thank you for your question. The next question comes from Dana Walker from Kalmar Investments. Please go ahead?

Hi, there.

Good morning, Dana.

Good morning. Bill, I think you may have confused people. If the Q1 comparison is easy is the 5% to 7%, is that a constant currency number or is that a reported number?

That is a constant currency 5% to 7%.

So despite the easy compare and the likelihood that the high value product compare would be strong, that 5% to 7% would be sort of frame the middle to the upper middle but not the above the top end of the range for the year?

Correct. Correct.

Okay.

There's still some -- you know, all of those factors that we talked about, the high value products returning, continued progress in the Delivery Systems space, but it's not an immediate, it's not turned the light switch off at the end of 2014 and turn it on in 2015. It will build. So, you know, our best guess based on the backlog that we have today and the timing of those orders, leads us to believe that 5% to 7% ex-currency is the best estimate we have today.

Question on currency. Can you and do you manage the business differently amongst all the different pressure points that you might have with the adversity of the exchange rate?

As you can expect, there are certain things we can do in certain regions. We've got the natural hedging that takes place where we can make and sell basically in the same currency. We do hedge oil and some of our raw materials as it is appropriate. But do not actively hedge the translation issue. So there are some things that we can control on the OpEx side that we will.

Oil is a bit complicated because of the nature of our supply contracts and the way that that is consumed in the manufacturing process. So we expect a bit of a tailwind from that in the latter half of the year. Collectively, all of those things are going to allow us to mitigate some of the FX impact but the change has been so dramatic over the last three to five months, we're note going to be able to mitigate all of it.

I suppose early in a year, no need in trying to be terribly precise and tight and yet your range seems to be quite large. Can you talk about the variables that would apply at the lower end of your range versus those that might apply to the higher end?

We've talked about all of them so we'll repeat them. It's the uptake of the return to more normal patterns for the high value products. It's the timing of devices and the proprietary device portfolio and a lot of the programs that Don talked about, you know, the sampling involved with them and hopeful eventual increase in sales resulting from those. On the pricing side, we know we're going to have very modest ability to pass along pricing.

Don talked about oil. It won't be as nearly a benefit today as it is perhaps in the second half of the year if, of course, if oil prices remain tame the way they are now in that, you know, $50 to $60 range we should get a nice tailwind from that. Lean operations and efficiencies in our plant continuing to work on the cost side of the equation. We will of course do that and try everything we can. So when we look at the totality of the picture, Dana and we think about, you know, all of those valuables and the volatility of some of the factors with our customers and how they operate in and around their inventories, their own inventories and the regulators and how the regulators impact on our customers.

As a reminder, we have $340 million worth of backlog. You know, we've got in [current] business we have over $1 billion of sales. So there's a big piece of that that will roll in over the rest of the ensuing months in the next few quarters. So at this time of year, we try to be as, you know, as thoughtful as we can about how all of those variables will impact and the $1.74 to $1.92 is the best estimate that we have at this point in time.

Understood. Don, you talked about the therapeutic categories that are most visible for some of your proprietary products on the delivery front. Can you shed some additional light if you can about your view as to what proportion of the need -- customer need might come within CZ or within SmartDose versus some other option.

It's hard to say because of the way our customers look at a device as part of their overall product launch and life extension strategy. As I look at it currently, we're participating on virtually all of these, mostly with closure systems for the vial and the syringe presentations. In the larger categories, many of those such as the PD1s are going mostly infusion so they're going to be done in a care center as opposed to a home environment. On the other drugs, we're in a good position. So I would say the lifestyle ones, devices are going to become more and more important. The chronic diseases on things like cancer and MS, not so much.

But the PD1 and the PSDSK9 biosimilars, I believe you mentioned as being categories where SmartDose and where CZ would apply or is it more expansive description of where you would be involved?

CZ potentially applies to all of them. The high value therapeutics where you have issues with breakage either in manufacturing or presentations in an auto-injector, or the drug is just aggressive, we think CZ as a primary container has broader applications. SmartDose is going to be again those applications where a high volume has to be delivered over time. And it can be done in a home setting or somewhere else. A lot of the oncologic drugs you don't want to do that because of their toxic nature. So the categories that you mentioned, SmartDose for rheumatoid arthritis, potentially for cholesterol reduction and others is going to be its biggest area of application.

And one final question on that. You addressed how your understanding as to where customers would be would be more evidenced by year end and yet what are you able to conclude now about trial length, trial conclusion, and how the regulatory pathway would be affected by these things?

Well, it all comes back to the timing of when the drugs that are on formal stability come off formal stability. We know of some customers that began trials in the latter part of 2013, early part of 2014. That data will be coming to the end of its two-year shelf life study at the close of 2015, beginning of 2016. We're hoping that we have a pretty good picture as to the commercialization potential for those molecules as we move towards the fourth quarter.

I'll step back. Thank you. Good stuff.

Thank you, Dana.

Thanks for your question. We'll now pass the call over to Don Morel for closing remarks.

Thank you very much, everybody. We appreciate your time this morning. We will look forward to speaking with you again at the end of our first quarter call which will take place in April. Thanks very much.

Thank you. Ladies and gentlemen that concludes the call for today. You may now disconnect..