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West Pharmaceutical Services, Inc. (NYSE:WST)

Barclays 2013 Global Healthcare Conference Call

March 14, 2013 9:30 AM ET

Executives

Bill Federici – VP and CFO

Analysts

Elliot Feldman – Barclays

Elliot Feldman – Barclays

Well great, good morning. My name is Elliot Feldman, I work in the Healthcare distribution and technology team here at Barclays. Welcome to day three of our Global Healthcare Conference.

Once again, I’m pleased to have West Pharmaceutical Services with us. Kicking us off today is Bill Federici, CFO, who will take us through a presentation. Mike Anderson also is here is well to help out. So, Bill could talk for about 20 to 25 minutes or so and then we’re going to head over to Point Center 4, just down the hallway here for an informal Q&A in the breakout session and we’ll go from there.

So, Mike, Bill, thanks again for being with us, welcome. I’m glad to have you guys back.

Bill Federici

Thank you Elliot. And thanks to Barclays for allowing us to come here and present to you today. I will call your attention to our Safe Harbor statements which give you some insights into the risks associated with our forward-looking statements.

Today, what we’re going to do is spend about, as Elliot said about 20 minutes talking through who we are, the fundamentals of our business, what’s making us grow, some of the results from 2012. And then give you some view of what we see as an outlook.

West is a global manufacturing company that since 1920s has been involved very closely with our customers in looking at how they can package their drug product. In fact if you have to boil everything down from our history, fundamentally, our expertise in understanding the way drugs interact with materials is critical to our business’ history and also to our future.

We do have a stable and diverse customer base nearly all the major pharmaceutical, biotechnology, medical device and generic customers, our companies, our customers of ours who we worked with three years, we enjoy large market share in the Western developed world and we have a small but growing market shares in the far emerging markets.

We operate in two business segments, our pharmaceutical packaging systems, business and our delivery systems business. The packaging systems business is where we produce all of the components, primary packages for injectable drugs. We produce 36 billion units a year for our customers and we’ll talk a little bit about the attributes that are associated with that.

And then in the delivery system business, which is primarily a contract manufacturing business today, 80% of our revenues in 2012, rough numbers were driven off of contract manufacturing. We also have a small but growing part of our businesses proprietary products and it’s very key to the future.

Our competitive advantages are many, let me talk about a few of them. In the packaging system space, we literally, as I mentioned earlier, we’re the category in the Western markets. We have 65% to 70% shares of the Western markets both in US and Europe. In the growing far emerging markets we have smaller shares but they are growing in double digits.

Important is from a differentiating perspective, the fact that we’re designed into our customer’s regulatory filings, when they produce a new drug and they are going to either the US regulators or the other regulators across the world, they have to include documentation around the package, the primary package. We – once we are on that package and it gets approved by the regulators, we are literally designed into that package, into that drug’s package.

So therefore for a customer to go ahead and change, it first of all it doesn’t happen very often. And it’s time consuming and very expensive, that creates a nice mode for the business.

In addition, our global footprint, we have invested well over a $1 billion in manufacturing capacity globally, that capacity, that investment ended the largest and geographic dispersion of that capacity is another huge mode for us, we are innovators.

We worked with our customers very closely for as I mentioned earlier 90 years. And in that time, we have come up with lot of innovations, us and our Japanese affiliates Daiki have come up with lot of innovations in terms of the primary drug package and that creates another nice mode for us.

In the delivery system space, I mentioned it’s a – primarily a contract manufacturing business. But our key differentiators there are – we are experts in taking a customer’s design of the drawing boards and creating a well engineered, well manufactured and highly automated process for that. So, literally taking it from the drawing and making it into a real high-end commercial product, that’s where we spend most of our time that’s 80% of that business. There is also about $80 million or 20% of the business that is associated with our own proprietary products into delivery system space and we’ll talk about the importance of that in the future.

If you think about the markets that we serve, you can see that we serve, you can see that this is an outlook from IMS and other data that shows that markets are growing but in the Western world where we have our largest market shares they’re not growing that great either pretty close to zero in Europe or somewhere in the 2.5% range for the United States and Japan.

But when you look at the far emerging markets it’s where all the growth is coming from, and we will talk about how we interface with that. Again, as I mentioned, we have small market shares in the far emerging markets but they are growing very fast.

So, why are injectables important and where are they going to grow from? If you think about injections – and you think about it from our perspective, we’ve been doing this for a very long time. But the key drivers of that growth are in therapeutic areas, the big ones are in the biologic space you’ve got the oncologics, you’ve got the auto-immune diseases, you’ve got the high-end vaccines, you’ve got generics, those are the primary drivers that we see driving growth from a therapeutic perspective. Those therapies are growing in the high single digits, to low double digits are going to continue to do so for the foreseeable future based on data from IMS and others.

And the underlying macro trends that are driving that growth are what you would expect, the ageing populations around the world. The increasing demand for western style healthcare that’s coming out of the emerging parts of the world China and India specifically. When we think about those types of attributes ageing populations and when you think about what’s going on, there is a large increase in chronic diseases. These chronic diseases as we’ve seen are more and more being addressed with therapies that are biologic based. Those biologics happen mostly be injected, almost all of them injected at this point in time.

And we happen to have very, very high market shares in the biologic space, greater than 90%. So, we see our ability to change, to continue to grow in that same high singles, low doubles, in those key therapeutic categories revolved around biologics and high in vaccine.

Another trend that’s happening is the macro trend in the customer’s need for very, very high quality and clean product. In order to meet the demands of the marketplace and to properly package these very aggressive and volatile and very expensive biotechnology drugs. They are demanding from us as manufacturers, the cleanest most high quality product we can get.

It’s a difficult thing to do but that’s what’s driving growth and we’re seeing that growth because they demand that high quality and the high cleanliness, we’re seeing demand, increased demand for our high value products which I’ll describe to you later.

So, where are we going to see growth coming from? What we see is, when we look out at the gross on the horizon, we don’t need to sell a whole lot and more units, it’s very modest unit growth coming from new demand for new biologics that are being created and for demand from the emerging markets. The rest of it we see very, very slow growth the geographic expansion as we talked about into China and India.

So, when we look at our high value products, we’re not going to see a lot of volume growth but we are going to see a lot of revenue and margin growth and that’s from both a little bit of pricing and mix. And when we say mix, what we’re talking about there is the ability to or the demand from the customer to have this cleaner, higher value product translates into us doing a lot more processing of that product post manufacturing.

So, you are manufacturing processes very simple, it’s heating pressure on synthetic rubber, produces heat that are then cut out into individual parts as individual parts then, if you’re going to use them on a biologic drug, they need to have a very special coating on it called Floratech which provides a barrier between the synthetic rubber and the drug which these biotech drugs need.

You’re also then going to wash it in a very special washing process called Westar, Westar is literally as I suggested, it’s very clean water that produces a very clean product when it comes out of it. Then you’re going to have to vision inspect with cameras because the human eye isn’t going to be able to catch some of the low levels or particularly that the customer is asking us to do. Then we’re going to have to bag it off in a clean room, all these attributes that we have that we talk about – those are what we call the favorable mix-shift. Because as we add more attributes, we get more revenue and more margin per unit, very, very important to us.

Under deliver system side, the growth is going to come from a number of areas, primarily in our proprietary space CZ which is a novel way of packaging drugs in CZ which is our developed by our Daiki affiliate. It’ a plastic, polymer and it has attributes that make it much more effective for packaging biologics which we’ll talk about in a little bit and then also looking at some of the macro trends that are going on towards packaging biologics that we’ll talk about in a minute.

The importance of high value products is depicted on this slide. What you see here that the three balls there, the green ball on the upper right hand side of this, of the slide is our high value packaging products. They roughly equate to biologics. We sell right now in 2012 that represented 41% of our total PPS, our Packaging Systems Components Sale.

And you can see that they’ve grown over the last five years, they’ve grown about 15% per year. And the margins are right around 50% gross margin.

The middle of the slide shows a blue ball that is our standard packaging products. Those are packaging for veterinary products or standard injections for things like antibiotics. Those things as you can see are growing under 5% over the last five years and carry it, a gross margin somewhere in the mid-20s. There is not a lot of difference between the standard product and the high value product in terms of its core manufacturing, those literally the same dimensions as the other, as the high value product.

It’s just that the high value product has all those special post manufacturing processes that we talked about. Westar, the Special Coatings, Vision Inspections and Bagging in the Clean Room that allow us to charge much more because of the customer’s demand for cleaner and more clean and more high value product.

The small grey dot on the lower left hand side are our disposal medical device components. We manufacture billions of components for certain of our customers that carry a very low margin and as you can see aren’t growing very much, but it’s only about $80 million part of our business.

We talked about geographic expansion into India and China. Very important, as we see our customers right now, what we’re doing is we’re following our customers as they migrate their manufacturing to that part of the world. There are a number of our large customers who have announced that they are going to be building plants either in China or in India. And we are there because they need us to be there to provide those plants with their products.

So, we’ve got one plant that’s already up and running, a plastics facility in China. We just finished construction on the second plant in China which will be Elastomers plant that is going through – the constructions done is going through the validation process, it will be ready for commercial production in the next quarter in Q2 of 2013. India, we put the spade in the ground at the end of last year, that will be an Elastomers and Metals facility that will begin production sometime in 2014.

Okay, what’s the strategic focus for West? It’s really interesting, what we have here is we have as we talked, we have the packaging systems business which is the pre-eminent manufacturer of primary packaging for injectable drugs. As primarily component manufacturing business, it’s a great business, it’s got great growth prospects as we suggested and we’ll continue to grow nicely.

We have elements of a delivery system, we’re manufacturing devices, most of it right now under contract manufacturing but we also have a growing proprietary business in delivery systems where we are manufacturing devices that are used to get drugs into the body.

The beauty of West is the combination of these two things into integrated delivery systems. When you think about where the market is going, what is the marketplace demanding. Well, for a number of reasons as we talked about whether it would be healthcare cost increasing or whether we talk about ageing of populations, there is a demand to be able to have injections be self administered. It’s a pill, it’s one thing. It’s pretty easy to get somebody to take a pill, you can teach him how to do it. But for some of these drugs, especially the biologics that are in a free stride or laugh like state, it’s extraordinarily complicated.

So, what we’re working on in the beauty of our business is we’re taking the expertise that we have in understanding how drugs and materials interact. We’re taking that along with our very, very important capabilities in manufacturing and automated assembly of complicated medical devices that we have in delivery systems and we’re pulling those things together that to create systems using CZ and other things to be able to help customers to get their product into a self-administered format.

The key here is that they have to be accurate, they have to be safe and they have to be easy to use. All of those things are attributes that we’re working on in our novel delivery system space.

I talked about CZ, CZ is important, very, very important to that story because a lot of the biologics that we see today on the market are very aggressive and very hard to package. And that aggressiveness and difficulty to package has caused some concerns that customers have with glass which is the primary packaging used today for injections.

As I mentioned, our Japanese affiliate has come up with this novel polymer called CZ Crystal Zenith, which they are selling currently in Japan that we’ve got a state needle version where the needle is actually molded into the vile, into the syringe that is available for the Western markets, which is the modality of delivering injections here in the Western markets.

What it does? The things that some of the problems that glass has either breakage in auto injectors or aggregation of the drug around the silicon particles that are used, silicon is used in a glass syringe to allow the proper break lose force for the injection, or de-lamination of viles, these biotechnology drugs are very aggressive and they literally will peel the glass, they’ll peel it right off the wall of the vile and put it into solution.

So, all of the CZ is, it helps customers work through all of these issues and it’s a very flexible format, it could be formatted and molded into many different format.

To mark those there is another take on this, there is another novel technology that we’re using, where things are going to be very exciting as we go forward. It’s an electronic patch injector system that we acquired. It allows – the beauty of this is it allows for the controlled delivery of very high volume high viscous drugs that haven’t been able to be packaged into the standard 1 ml standard format of injection.

So, what we’re seeing here is we’re seeing a very flexible format that allows the innovators who are working on figuring out how to package these biologic drugs that maybe either be high volume or very highly viscous into a package that can be easily self administered, very exciting to a new format that a lot of our biologic formulators are looking at with great interest.

2012 was a really good year for us, very strong operating results. We grew over 10%, our margins at 30.6 on a consolidated basis, we’re 210 basis points higher than before. Mike and his team did accretive repurchase of our convertible debt which is helping our EPS going forward.

As I mentioned we completed construction in China, we’re working on, started the construction of our India facilities. It’s a very exciting time for West.

Looking forward, if you think about what are the things that we’re seeing on the horizon, we’re seeing a lot of growth that’s going to come through in the form of mix-shift. We talked about it earlier in the either whether you look at on the packaging system side where you look at growth in components, high value components for biologics, where you look at the delivery system side in terms of creating these systems, these integrated systems that are going to help customers put their package in – put their drug into a self-injectable package these are very, very good times.

We are seeing some things that are impacting those results though that we want to call to your attention. I mean, we are going to continue to see high value product growth both – on both sides of the segment. But we are seeing some increase in inventory, customer inventory management activity. And whether that’s related to risks like the Fukushima accident from a few years back or whether it’s just related to the fact that our lead times are expanding, customers are ordering more – they are ordering more frequently and their orders are higher.

So, what we tried to do is we try to strip out what is that – what impact does that have on our results. So when we look at that at that 10% growth that we had last year, a part of that is due to some of these extra orders that we see from either risk mitigation or from the inventory building activities.

We know the new facilities actually will be a drag on earnings this year, because there is a lot of start-up cost with those facilities as they come up to speed. You can’t just turn the light switch on and have them being 100% utilized to take some time.

And currency, we know we have a currency volatility issues and commodity volatility issues, both impact our business. Longer term, we continue to see the high value products be that story for driving growth in the future. We’ll continue with our productivity gains at lean programs. We’re going to execute in China and India and we’re waiting in the back half of our plan. We expect to see the uptake begin of CZ in the marketplace.

So, key takeaway messages, very important. We’ve got a very strong vibrant growing business where we are designed into the customer’s products which creates a huge growing annuity business. And we have the novel side of our business, the novel proprietary device integrated delivery system part of our business, that’s going to continue to grow, it won’t impact much today or tomorrow but in the back half of our five-year plan, it’s going to be a very important part.

We’re well positioned to grow in the Asia markets. We’re following our customers there. We’ve got plants on the ground and are building plants on the ground to help them. We’ve got a very strong balance sheet, our operating cash flows are growing with the results that we have. We’ve got a very disciplined experienced management team. Our incentives are aligned very closely with increasing shareholder value. And lastly we’ve increased our dividend – annual dividend every year since 1993.

So, I’d like to thank you for your time this morning. And as Elliot did say, we’ll be just down the hall at Point Center 4, for our breakout session. Thank you very much.

Question-and-Answer Session

[No Q&A session for this event]

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