西式醫藥服務 (WST) 2017 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to West Pharmaceutical's First Quarter 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to turn the conference over to Quintin Lai, Vice President of Investor Relations. Sir, you may begin.

Thank you, Taquia. Good morning, and welcome to West's First Quarter 2017 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. This morning, CEO, Eric Green; and CFO, Bill Federici, will review our results, give you an update on our business and provide an updated financial outlook for the full year 2017. There's a slide presentation that accompanies today's conference call, and a copy of that presentation is also available on the Investors section of our website. On Slide 2 is the Safe Harbor statement.

Statements made by management on this call and in the presentation contain forward-looking statements within the meaning of U.S. federal securities laws. These statements are based on management's beliefs and assumptions, current expectations, estimates and forecasts. There are many factors that can influence the company's future results that are beyond the ability of the company to control or predict. Because of these known or unknown risk or uncertainties, actual results could differ materially from past results and those expressed or implied in any forward-looking statement. For a nonexclusive list of factors, which could cause actual results to differ from our expectations. Please refer to today's press release as well as any further disclosures that company makes regarding the risk to which it is subject in the company's 10-K, 1 10-Q and 8-K reports. In addition, during today's call, management will make reference to non-GAAP financial measures, including sales at constant currency, organic sales, adjusted operating profit, adjusted operating profit margin 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 this morning's earnings release.

I will now call -- I will now turn the call over to West's CEO and President, Eric Green. Eric?

Great. Thank you, Quintin and good morning, everyone. We are pleased that you could join us today for our Q1 call. We're off to a good start to 2017. In the first quarter, we generated solid organic sales growth of 8.7%, with good contributions from both segments. We expanded growth and operating profit margins in the quarter. We launched new products and increased capacity with our Dublin contract manufacturing expansion, which is now online. And we continue to invest in the future with the first phase at our Waterford, Ireland facility on track to be operational and delivering validated customer samples in 2017. We generated a record high diluted earnings per share of $0.81 for the quarter. Excluding the benefits from a new accounting rule for tax deductions related to stock-based comp expense we would've grown adjusted diluted EPS by 13%.

On Slide 4, we present organic sales growth over the last 5 quarters. As you can see, our overall organic sales growth has been in the 8% to 10% range over this period. But when we look at the individual market units, as we previously discussed, there's more quarter-to-quarter variability. Our ability to serve these market groups, despite these changes in demand, demonstrates the strength of our scale and the depth of our capabilities. In aggregate, the long-term dynamics across our end markets remain robust. And we are uniquely positioned to serve these diverse customer groups.

Let me review our Q1 performance in the context of our end markets. Our strategy for growth remains focused on increasing the adoption rate of our high-value products. We are also working to secure more opportunities for our customers to use multiple West's products for each of those delivered and we see customers responding positively to this strategy. In our Pharma market unit, we had strong double-digit sales performance. The growth was a result of very strong high-value product sales, coupled with favorable year-over-year comparison due to inventory adjustments by our customers. There was also some favorable pricing adjustments made in certain regions impacted by inflation. We expect Pharma to return to more typical mid-single-digit sales growth, resulting in high single-digit growth for the full year.

As we saw last quarter, our Generics market unit declined mid-single digits as customers continue to work off safety stock accumulated in the first half of 2016. We have improved lead times for many of our high-value products and in turn, our customers have been able to reduce their inventory levels. For Generics, we expect to see increased momentum as the year goes on. We have already seen some large customers place meaningful high-value product orders for second half delivery. We expect Generics to return to high single-digit growth in the latter part of 2017, which will result in mid-single-digit growth for the full year.

In the Biologics market unit, we saw mid-single-digit growth as we cycled against the strongest growth quarter of last year due to inventory bills and support of commercial drug launches. In this quarter, we experienced some destocking by customers but not at the same level and Generics. And we expect it return to double-digit growth in Q2 and for the remainder of the year. Importantly, commercial activity for both SmartDose and CZ remains high. We have multiple SmartDose programs at an early stage and established commercial programs in place for both SmartDose and CZ. Developments for larger volume and preloaded versions of our SmartDose device platform as well as connectivity features are raising interest from our customers, especially within our biologics and emerging biotech customer base.

In contract manufacturing, we achieved a second straight quarter of double-digit growth. Along with the favorable comparison from last year's first quarter, we are seeing the results as expected from the many [tooling] projects with support of new programs secured in the back half of 2016. Because of the longer lead times of some of these projects, we have good visibility into the back half of the year, which should produce high single-digit growth in this segment.

On Slide 5. This shows our product portfolio and represents the value we bring to our customers with the value, those products and services bring to West. We recognize that our long-term success depends on our ability to keep our product pipeline full of advanced containment and delivery solutions. The product shown above the arrow represents some of the new products that have recently been launched or will soon be launched. I'm pleased with the progress of our global Innovation and Technology team and their work to expand our portfolio. We do know it takes time for many of these products to achieve substantial commercial volumes as our customers make their way through the drug development cycle, but we are pleased with our cadence of new product launches.

While working with our customers, particularly during Phase I or II, we're able to support them from concept, to the development, to launch. As a result, we've seen high percentage of FDA approved injectables, using either West or Daikyo components. In fact, we are pleased to report that our products are used in all 5 of the new biologic medicines approved by the FDA in the first quarter of this year. Most recently, I got a chance to speak with some of our top customers at the March DCAT conference in New York. It was a great pleasure to get their feedback in how West is successfully partnering with them to get their products to the market. What I heard most frequently was how much they value and appreciate the deep technical insight, their teams offer. They also noted the importance of our collaboration to continuously to improve, so that together we can assure we deliver the highest quality level each and every day.

It's not just about the products we make. To hear from our customers on how much they value our scientific affairs and technical services as well as our regulatory affairs and assistance with filings. It underscores that West is the scientific destination for an integrated containment and delivery of injectable medicines. We are striving to provide value at every possible touch point we have with our customers as part of our market-led strategy. Turning to Slide 6. With a good start to the year, we remain focused on delivering critical high-value products to our customers, offering differentiating contract manufacturing services and further developing our growing self-injection platforms. We are maintaining a 7% to 9% organic sales growth guidance for the year, and raising our adjusted EPS guidance.

I'll now turn it over to our CFO, Bill Federici, who will take you through our detailed financial results for the quarter. Bill?

Thank you, Eric, and good morning, everyone. We issued our results this morning, reporting first quarter 2017 earnings of $60.9 million or $0.81 per diluted share versus the $0.30 per diluted share we reported in the first quarter of 2016. Those results are summarized in Slide 7.

Our Q1 2017 reported results, include a $15.9 million or $0.21 EPS tax benefit, associated with our adoption of the new accounting standard regarding share-based payments. Our Q1 2016 reported results, include a restructuring charge and a Venezuela and devaluation charge. Excluding those nonrecurring items, our Q1 2016 adjusted diluted EPS was $0.53. Those 2016 non-GAAP measures are described in Slides 13 to 16. Turning to sales. Slide 8 shows the components of our consolidated sales increase. Consolidated first quarter sales were $387.7 million, an increase of 8.7% over the first quarter '16 sales, excluding translation exchange effects. Proprietary product sales increased 8% versus the same quarter in 2016, excluding unfavorable translation exchange effects. Volume increased is contributed 5.7% of the proprietary sales increase. Our high-value product components and systems sales increased 8% versus the prior year first quarter. As expected, the quarters -- the current quarter, HVP sales were adversely impacted by customer inventory management, especially in our Generics and Biologics market units. The current quarter's HVP sale as a percentage of total proprietary sales were constant versus the prior year quarter, and represent more than 50% of our total proprietary products in Q1 2017 sales.

For the full year 2017, we expect double-digit sales growth in high-value products. CZ and SmartDose sales grew double digits in the current quarter versus the prior year quarter. Contract-Manufactured Product net sales increased by 11.4% versus the prior year quarter excluding exchange. A favorable mix of products sold, volume increases and pricing drove the increase in Q1 2017 sales . This quarter's growth was favorably impacted by the ramping up of some customers projects in our Dublin facility. We expect high single-digit sales growth in contract manufacturing for the full year 2017.

As provided on Slide 9, our consolidated gross profit margin for Q1 2017 was 34.6% versus the 34% margin we achieved in the first quarter of '16. Proprietary Products first quarter gross margin, a 39.2% was 40 basis points higher than the 38.8% achieved in the first quarter of 2016. The increase in gross margin is due to price increases and operational efficiencies, offset by a slightly unfavorable mix of products sold, and normal inflationary increases in labor and overhead and overhead costs.

Our Venezuelan and operation's favorable currency impacting the current quarter was partially offset by yen currency losses on material purchases and an unfavorable currency translation effect in Europe. Contract-Manufactured Products first quarter gross margin increased by 160 basis points to 16.3% compared to the prior year quarter. The current quarter's higher gross margin is primarily due to the favorable mix of product sold and operational efficiencies, offset by normal material labor and overhead cost increases.

As reflected to on Slide 10, Q1 2017 consolidated SG&A expense increased by $3.5 million versus the prior year quarter. As a percentage of sales, first quarter 2017 SG&A expense was 15.9% versus 16% in the first quarter of '16. Pension cost decreased by $1 million in the quarter, and were offset by higher compensation expense, including merry increases and increased IT cost. Foreign-exchange had a favorable effect, reducing SG&A expenses by $400,000.

Slide 11 shows our key cash flow metrics. Operating cash flow was $20.7 million for the current quarter, $17 million more than the prior year quarter, primarily reflecting the higher net income and the new accounting standards classification of the excess tax benefit on share-based payments as part of operating cash flows. Our capital spending was $37.5 million in the current quarter. We expect to spend to approximately $150 million to $175 million in capital in 2017. More than half of our planned capital spending is dedicated to new products and expansion initiatives, including $25 million in Waterford.

Slide 11 also 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 of $169 million was $34 million less than our December '16 balance. Approximately, $27 million of our cash was used to buy back 325,000 shares of our common stock under the board authorized share buyback plan. And we made a $20 million voluntary contribution to our pension plan. While a large portion of our cash remains invested overseas and is generally not available to be repatriated to the U.S., while incurring tax consequences. We continue to pursue repatriation of certain offshore cash where possible.

Debt at March 31, of $228 million is essentially at the same level as that of year-end. Our net debt to total invested capital ratio at quarter end was 4.8%. Working capital of $396 million at March 31, was $5 million lower than at year-end. The majority of the decrease is due to the reduction in cash and the reclassification of long-term debt to current, offset by increases in inventories and receivables relating to our growth in our business.

Our committed Proprietary Products orders of $408 million at March 2017, were 8% higher than at year-end but 5% lower than the March 2016 orders excluding exchange. The March 2016 committed orders were impacted by our extended lead times for certain high-value products.

Turning to Slide 12. We are increasing our full year 2017 EPS guidance range by $0.21 to reflect the Q1 excess tax benefit on stock transactions. We are reaffirming our other annual guidance provided previously. We have based our guidance on an exchange rate of $1.05 per euro, the same rate used in our prior guidance. Our 2017 guidance excludes any additional impact from further currency devaluations, including the Venezuelan bolivar as the company continues to operate primarily under the official exchange rate. It also excludes the expected additional expense associated with our restructuring program.

I'd now like to turn the call back over to Eric Green. Eric?

Great. Thank you, Bill. In conclusion, we delivered a solid set of results for the first quarter of 2017. We are driving high-value product growth in our Proprietary Products segment, and expanding our contract manufacturing services. Our Global Operations is driving more efficient production, higher quality and better service. Delivering significant value to our customers and the patients they serve. And our Innovation and Technology team continues to fill our product pipeline with exciting new developments and primary containment and delivery. We're off to a good start, and I look forward to making additional progress and executing our market-led strategy in 2017.

Taquia, we are ready to take questions. Thank you.

(Operator Instructions) Our first question comes from Derik De Bruin with Bank of America Merrill Lynch.

So I got a just a few housekeeping questions then I got a bigger one. Bill, the tax guide for 2017 is -- the bulk of the benefits in the first quarter. How does the rest of the quarter pace out and what's the guide for the full year tax rate?

Full year tax rate's going to be right around 29%. It excludes that tax benefit that we picked up from the share based payments adopting that new accounting pronouncement. That's why the first quarter is so low.

Got you. Okay. Great. And the top line impact from FX, are you looking for this now?

Well FX is right now, we're guiding to $1.05 per euro. Right now, obviously it's a little higher than that. But we'll put a stake in the ground and continue to monitor that and report on that on the quarterly basis. But right now it's a headwind to us -- for us from the euro.

Got it. Okay. Share count?

Share count, we're hoping to remain relatively flat, because we have that share buyback plan that we've -- that the board authorized and we put in place. So we're hoping to keep it relatively flat.

Great. Bigger question now. Could you just walk a little bit about the Biologics. You had a tough comp and it's clear you are also seeing some draw down, you saw some draw down in inventory, it sounds like. Just talk about what you're seeing in the market? And then how, where -- is there any update in terms of where your customers are in adopting Crystal Zenith and then I'll shut up.

Yes, Derik, it's a good question. When you look at the Biologics, similar to last year, where we had a period of time that was a bit slightly less than other 3 quarters. That's what we're expecting this year in 2017. And the markets themselves are still, as far as a unit volume perspective, mid to high single-digit. And we expect to grow faster than that, obviously. But working with our customers, with the inventory management, again this leads to the high-value product focus of reducing cycle times, just to put a dimension on it slightly, in a couple of our plants that produce mostly the high-value products. We saw a nice reduction about 20 -- roughly around 20% reduction. That obviously is migrating back to our customers and there is again higher degree of confidence in there for them, pulling back on their inventories. As we've said, we're pretty clear that we'll see an increase in growth rate over prior year to back to the double-digit starting this quarter in Q2 and going forward. So we're feeling pretty good about that. In regards to the CZ, we've seen as a little slight increase, the interest level, when you start looking at free stability, stability and in getting it ready for launch, in those 3 buckets we are seeing an increase, which is favorable. As you know, it does take time, it does depend on approvals and customers, getting it ready for launch. But we're still feeling pretty good about that portfolio at this time.

Our next question comes from Tim Evans with Wells Fargo.

This is Sara Silverman on for Tim. I have a margin question for you. You guys had pretty solid margin gains in the quarter, and I'd like to look at some of the components. You guys call out about 100 basis points of efficiency gain but then volume and mix was about a 30 basis points headwind. Can you guys talk about kind of what exactly are you doing to gain the efficiencies and then also talk about why volume and mix was a negative contributor since this is kind of a reversal off of the historical trend?

Yes, Sara. Let me start with the efficiencies. Last year, we embarked on, as you know, well over a year ago we embarked on a really a different focus around our operations. We've globalized, historically ran up from the site and region perspective and it was effective at that time but going forward, we felt we could bring more of a global approach. We brought a leadership into the organization. And frankly, we starting to see good traction. And looking at how we can move certain products, I mean, produce in certain regions and their locations more effectively to really balance our load. When I look at the operations there's really four key levers we're focused on: one, we're already at pretty high level on quality but rule one has already moved the bar even further north; the second one's on service, the lead time focused on reducing it to a more than acceptable point by our customers is we are definitely on that journey; the third one's global lean initiatives. They're starting to kick in, we're going more global operations, global lean principles, we're starting to see early traction. And the fourth one's going to take a little more time, but it’s really the global manufacturing strategy and looking at capacity, opportunities and leveraging scale. We spend, obviously, quite a bit on CapEx. We're looking at how we can leverage our assets more effectively going forward this global approach. I think Bill, do you want to talk little bit about the mix effect?

Sure. So mix, Sara. Was slightly negative, it was slightly unfavorable and it's directly tied to the lower growth rates in both Biologics and Generics.

Okay. So going forward, do you think that mix should continue to be a positive contributor to margins?

Exactly. Right. So when we think about it, as Eric mentioned it in his comments, that returning Biologics, returning to double digits in the second quarter and then also seeing Generics ramp up by the end of the year. All of those will help with the mix going forward.

Okay. Great. And then just a quick follow-up on the CZ question. You guys had about $27 million of CZ and SmartDose last year. Do you guys expect that line to grow materially this year?

Yes. We expect that to continue to grow in the double-digits.

Our next question comes from Larry Solow with CJS Securities.

Bunch of moving parts, obviously, with timing or what not. Just curious, I know we expected a little bit more of a back-end loaded year. Is most of the difference there just a little bit of the pull forward on the contract manufacturing side? Or what sort of -- or is the quarter maybe a little bit better than your internal outside of timing?

Yes. I think we're going to see in the back half of this year is more of the ramp up on the Generics space as you recall that, we have a few large customers in that space that really moved the needle quickly. And so again, I'm very pleased with our operations really driving down cycle times, therefore, the higher degree of confidence. But the demand in the Generics is still rather robust. So we're pretty confident there. In the Biologics again, that's more of a ramp up back to double digits in Q2 and beyond. So when you have that effect of those 2, which is about 50% of our business and most of that is high-value product portfolio. The contract manufacturing, just a quick comment. While it was double digits in the last 2 quarters, we anticipate a similar type of growth going forward, however, when you look at the Q4 as part of the growth percentage, it's going against the very high comp. So we should look at the contract manufacturing as a very stable predictable revenue run rate for that business, especially after investing in the facilities in Dublin.

Okay. And just on the contract manufacturing side, just a quick aside there. And on the gross margin on that segment, it did increase pretty nicely year-over-year. I assume, it's just timing related, it's still sort of in Q1 normally is a little bit lower but it still remains sort of lower probably than your full year outlook. Even though, you had a decent rebound in growth. Is there anything else in there that's sort of impacted that should sort of wane as the year progresses?

So Larry, as you remember, we had a bunch of tooling stuff going on in the fourth quarter, that has actually now produced usable capacity and that capacity is being filled by our customers. So that's obviously helping with the increase in the margins. And there's also some good operational efficiency going on in there as well. So those things we continue, as Eric said, we continue to think that, that’s going to continue to build for the year.

Got it. And then just lastly. It sounds like you guys are, obviously, improved your throughput and your capacity over the last 2 quarters, which is I guess comforting to your customers and that's led to some slowdown in orders which were probably a little bit ahead of the game last year. Do you think we are sort of getting closer to -- I guess you know about equilibrium but less volatility in the order line going forward?

Yes. I would say at this point we're going to see less volatility. I think we're more in a stable state. But I will keep on challenging [the applications] to find ways to even improve the cycle times so that it's uniquely in a new space. So as we go forward, you'll see that reflected in our committed orders. We do want to keep continuing to push the cycle times down to be more in line with our customer expectations.

Our next question comes from Dave Windley with Jefferies.

This is Jared Meggison on for Dave this morning. I just have a couple of quick one's. Can you guys elaborate a little bit more on Waterford and kind of the impact you guys expect there in 2018. I know -- I don't want to jump forward too much. But just curious, what kind of impact this could have, kind of on a long-term basis?

Yes. While we're in the process -- at the end of this year, we'll be working with our customers especially in influence phase on validating samples. And once the validation process has been completed, we can start moving into commercial revenues. But as you know, in this space, in this business, it does take a while to ramp up. So I would argue that in 2018, while we'll see ramp up in commercial it's not going to be really significant. It's going to be in line with our expectations but it's not going to be a significant hit to our top line in '18.

Got you. And then just real quickly on the customer inventory management. I'm just curious to what kind of dive in your guys visibility on that. And kind of ability to forecast?

Well, you know one of the-- you're absolutely correct. That's one of the reasons why we realigned our organization to the market led. So our Generics team is just focused on our Generics customers, they're having discussions day in, day out, and they are working with the operations, to translate that into capacity and utilization of our facilities. We're getting better at it. Can we improve? I think we can. But I would say we are getting better visibility. Some of it is a little bit variability of our customers as they move in out, in and out of ability to produce. Unfortunately, some of our customers are going through difficult times with the FDA, but that translates into another location still. So there's some moving parts for that business, but we are gaining better visibility. I do believe we have some room for improvement.

Our next question comes from William March with Janney.

This is Bill on for Paul Knight. So first question, just on the Generic business. Obviously, customers have been working off of backlog over the past couple of quarters. With the backlog also kind of flat year-over-year, are you starting to see more customers interested in high-value products, and so some of them are maybe burning of standard products to upgrade. Just what are you seeing from that customer segment?

Yes, Bill I wouldn't correlate that exactly to the transition from standard to high-value products. There is a transition occurring. And I can -- we have discrete cases to point to. However, what we're seeing is, as the -- we've seen the momentum of new committed orders coming in, which is building on upon the backlog at this time. So as you'll recall, it's roughly around 8% increase as of end of last year. Last year, we saw the pullback in inventories, probably more of the latter part. Because it was after we had a discussion in October. In between October and December, we knew it's going to be probably good -- roughly approximately about 6 months to work out. So we're -- Q1 was right in the middle of that or in the beginning of at this point. So I would say, it's a combination of both transition from standard to high-value parts but also destocking with some of our large customers.

Got it. And on the CZ and SmartDose. Could you just give us an update on the number of trials that are currently utilizing those 2 products?

Yes, so as I mentioned earlier, we're trying to get away from the exact number every time. But I would say that, when you're talking about CZ, there's an increase, a slight increase. SmartDose is relatively the same, as last quarter as we talked about. Plus there's more conversations, in fact, quite a bit more conversations happening right now around DAs and around sampling of -- discussions about variations of the product to support various drug therapies. So it's slightly better than what we talked about last quarter.

Got it. And just one quick one for Bill. Bill, over the past 6 quarters or so, return on invested capital has really been moving up about 400, 500 basis points. Could you just maybe highlight what's driving that?

Well certainly, the high-value product growth that we've seen over the last several quarters, in fact over the last couple of years has been very, very strong. And that drives the favorable mix shift. We're doing a great job of operational efficiencies. We're doing a great job of getting good leverage out of the other parts of the business. So those things are all helping produce. At the same time, we are -- we continue to invest in the business and that will continue to be a drag on our return on invested capital. But we're doing it in a prudent way, making sure we're investing in those things like high-value product capacity to be able -- to continue to grow at the rates that we've been able to grow. So yes, I think the 2 biggest drivers are HVP growth and the operational efficiency.

Thank you. I'm showing no further questions at this time. I would like to turn the conference back over to Quintin Lai, Vice President of Investor Relation, for any closing remarks.

Thank you, Taquia. Thank you, for joining us on today's conference call. An online archive of the broadcast will be available on our website at westpharma.com in the Investors section. Additionally, you may access a telephone replay through Thursday, May 4, by dialing the numbers and conference ID provided at the end of today's earnings release. That concludes this call. Thanks, and have a great day.

Ladies and gentleman, thank you for your participation in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.