West Pharmaceutical Services' CEO Discusses Q1 2013 Results - Earnings Call Transcript

May. 2.13 | About: West Pharmaceutical (WST)

West Pharmaceutical Services, Inc. (NYSE:WST)

Q1 2013 Earnings Call

May 2, 2013 9:00 am ET

Executives

John Woolford – Investor Relations-Westwicke Partners

Donald E. Morel – Chairman and Chief Executive Officer

William J. Federici – Vice President and Chief Financial Officer

Analysts

Arnie Ursaner – CJS Securities

Ross Taylor – CL King

Operator

Welcome to the West Pharmaceutical Services First Quarter 2013 conference call. At this time, all participants are in a listen-only mode. If you require operator assistance at any time, please press star then zero on your telephone keypad, and a coordinator will be pleased to assist you. (inaudible) this call is being recorded on behalf of West and is copyrighted material. It cannot be rerecorded or rebroadcast without the company’s expressed permission. Your participation in this call implies your consent to our taping. If you have any objection, you may disconnect at this time.

Now I’d like to turn the call over – sorry, turn today’s meeting over to Mr. John Woolford from Westwicke Partners. Sir, you may begin.

John Woolford

Thank you, operator. Good morning everyone and welcome to West’s first quarter 2013 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 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 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 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 US Federal Securities law and that are based on management’s beliefs and assumptions, current expectations, estimates and forecasts.

Many of the factors that will determine the company’s future results are beyond the ability of the company to control or predict. These statements are subject to known or unknown risks or uncertainties and therefore actual results could differ materially from past results and those expressed or implied in any forward-looking statement.

For a non-exclusive list of factors which could cause actual results to differ from expectations, please refer to today’s press release, as well as any further disclosures the company makes on related subjects in the company’s 10-K, 10-Q, and 8-K reports.

In addition, during today’s call management may make reference to non-GAAP financial measures including adjusting 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 would like to turn the call over to Don Morel, West’s Chairman and CEO. Don?

Donald Morel

Thank you very much, John, and good morning everyone. Welcome to this morning’s conference call, where both Federici and I will be reviewing West’s Q1 2013 performance and our outlook for the remainder of the year. As in past calls, we will refer to a PowerPoint slide deck to support our commentary. The deck can be accessed via our website under Investors. However, if you cannot access the file, the information in the slides is covered in both this morning’s release and our prepared remarks.

Beginning with slide number three, West had a very good first quarter with consolidated revenues increasing 7.2% to just over $339 million, excluding currency effects as a result of ongoing strong demand in both operating segments. Sales in the packaging system segment grew by 6.6% and delivery systems grew by 9.1%, again excluding the effects of currency.

Our consolidated gross margin for the quarter improved to 1 core percentage point to 32.9%, and adjusted operating profit improved by $1 million when compared with the prior year. Operating profit growth was offset by the combined effects of an increase in SG&A and R&D spending, an increase in variable stock-based incentive compensation, and Venezuela’s currency devaluation. For the quarter, adjusted earnings per share were $0.87, an improvement of $0.04 versus the first quarter of 2012.

Additional segment details are provided on slide number four. Pharmaceutical packaging sales were again driven by volume growth, a positive mix bolstered by higher sales of our advanced packaging products such as Westar ready-to-use components, FluroTec, and Envision, and higher selling prices in key product lines. Delivery system sales grew as a result of strong demand for contract manufacturing services with existing healthcare customers, orders for CZ vials and cartridges, and proprietary devices for reconstitution and safety. Overall sales of proprietary systems accounted for 25% of total delivery system revenue, up from just over 21% in the first quarter of 2012.

Our current backlog of firm committed orders at the end of the quarter grew again, reaching almost $375 million, an increase of approximately 16% compared to the end of the first quarter of 2012, and approximately 3% from the fourth quarter of 2012, excluding currency. This sequential pattern is more in line with historical norms, as customers typically place larger orders at the outset of the year and then work down inventory through the first two quarters. As was the case at the end of 2012, the composition of the backlog is currently weighted towards the high-value products.

Given the expansion in our backlog for those products, and the resulting increase in lead times for certain product categories, our commercial and operations teams continue to work proactively with our customers to ensure their inventory and production needs are understood and factored into our manufacturing capacity planning.

Based on our current order book and the heavier weighting of value-added products in the backlog, we currently expect growth rate in the second quarter to be in line with Q1.

Slide number five provides a high-level summary of our major expansion in new product development programs. As presented in our February call, the investments we made over the past two years in [washing] capacity and vision systems clearly are bearing fruit as we continue to see double-digit growth in the high value product category in the packaging systems segment. The market need for ultra-clean packaging systems will continue to be driven by tightening regulatory requirement, rising sales of approved protein-based drugs, and new biologic therapies currently in Phase III trial. We are selectively adding capacity in these product lines within our existing footprint, and beginning the process of converting our Kinston, North Carolina, facility to a pharmaceutical grade plant.

We have completed initial validation and test sample production of our China elastomer facility and remain on plan to begin commercial production once we receive customer approval. The construction of our India plant is well under way and scheduled to initiate metal seal production in early 2014, followed by rubber production in 2015. Once online, both the China and India operations will provide much-needed capacity for the region, and will allow increased production of high-value components in our Singapore facility to support forecasted growth in the Asia-Pacific market.

Proprietary sales in the delivery systems group reached almost 25% of sales during the quarter. CZ revenues comprised of vials, cartridges and the 1 ml long syringe hit $3.5 million, substantially higher than the modest start to 2012. The 1 ml long syringe is currently in use for the first time in its human clinical trial. We expect double-digit increases in sales of our proprietary systems during 2013, including CZ, following on its 16% increase during 2012. CZ revenues for the full year should fall in the range of $11 million to $14 million. As a reminder, the most important milestone is the number of formal stability trials begun this year to incorporate CZ as the primary container.

While we expect CZ revenues to be somewhat modest over the next 18 months, the formal stability trial puts a critical stake in the ground in terms of timing for its commercialization.

Development work on our proprietary SmartDose infusion system is progressing on schedule. Following up on our production of demonstration and training units in the fourth quarter of 2012, we achieved our second key production goal by delivering several thousand units for the first clinical trial, which we expect to start later this year. Sales of the [Hira] safety system and Medimop reconstitution products were also strong during the quarter. And we began to scale up our next generation NovaGuard safety system in both a 1 ml long and 0.5 ml configuration.

Turning to our outlook for the remainder of 2013, as outlined on slide number six and in this morning’s release, we believe sales growth for the year will fall between 7% and 9%, yielding revenues in the range of $1.36 billion to $1.4 billion at constant exchange rates. The primary driver for packaging systems with be increased sales of our high value product line, whereas in delivery systems the ongoing shift to proprietary products and steady demand for contract manufacturing services will be key. We are forecasting improvement in our full year consolidated gross margins which, when coupled with our assumptions for SG&A and R&D spending, should produce full-year adjusted earnings in the range of $3.05 to $3.20 per share, assuming a dollar euro exchange rate of 1.30 for the remainder of the year.

We remain firmly committed to our strategy of focusing on expansion of our value-added product lines and packaging systems, while continuing to invest in technologies and products to address currently unmet market needs for the safe, accurate and simple administration of injectable drugs. Our investments in both new product development and our manufacturing footprint over the last few years have put us in an excellent position to deliver organic growth consistent with the range outlined in our five-year plan objective.

I would now like to turn the call over to Bill Federici for a more detailed discussion of our financial results. Bill?

William Federici

Thank you, Don, and good morning everyone. We issued our first quarter results this morning, reporting net income of $31.7 million or $0.90 per diluted share versus the $0.81 per diluted share we reported in the first quarter of ‘12. Our first-quarter results are summarized on slide three in the accompanying PowerPoint presentation and in the release. As explained in the release, excluding the effects of one-time items in both periods, our first-quarter 2013 earnings were $0.87 per diluted share versus the $0.83 we earned in Q1 2012.

Turning to sales, slide seven shows the components of our consolidated sales increase. Consolidated first quarter sales were $339.4 million, an increase of 7.2% over first quarter 2012 sales, excluding exchange.

Packaging systems sales increased 6.6% over the same quarter 2012 sales excluding exchange effects. Sales price increases in packaging systems contributed approximately 2.4 percentage points of the increase. The majority of our sales increases is attributed to the favorable mix of products sold that are high-value products growing 11.2% over the prior year first quarter. We continue to experience very strong demand in Europe, where sales increased 10.3% at constant exchange rates over Q1 2012, leading to longer lead times and growth in our sales backlog.

Delivery systems sales increased by 9.1% or $7.4 million over sales in the prior year quarter, excluding exchange. Crystal Zenith product sales were $3 million above Q1 2012 level. Much of the CZ sales increase was driven by cartridge samples provided for a customer sponsored clinical trial.

Sales of proprietary products were $22 million or 25% of the segment’s revenue in the quarter, ahead of the prior year quarter’s 21%. As provided on slide eight, our consolidated gross profit margin for Q1 2013 was 32.9% versus the 31.9% margin we achieved in the first quarter of ’12. Packaging systems first quarter gross margin of 37.7% was 1.6 margin points higher than the 36.1% achieved in the first quarter of 2012.

Most of the improvement reflects the favorable sales mix resulting from conversions to high-value products. In addition, sales price increases and production efficiencies offset higher plant operating and raw material costs. Delivery systems first quarter gross margin declined by six tenths of a margin point to 19.1% compared to the prior year quarter. Although CZ sales were higher than the previous quarter, most of that increase was on lower margin cartridge samples. The 2012 first quarter benefited from the one-time $500,000 cost reimbursement from a customer. Excluding that payment Q1 2013 margins are equal to those of the prior year quarter.

As reflected on slide nine, Q1 2013 consolidated SG&A expense increased by $7.8 million versus the prior year quarter. As a percentage of sales, first quarter 2013 SG&A was 17.4% versus 16.2% in the first quarter of 2012. Stock-based compensation and incentive costs were $2.3 million higher than a year ago, primarily as a result of increase in our stock price during the quarter, as well as higher achievement levels on performance-based share grants. Other compensation costs were $2.1 million higher, including annual salary increases and increased staffing in Europe and Asia, increases in IT cost and outside services, and higher sales commissions account for the remaining increase.

Slide 10 shows our key cash flow metrics. Operating cash flow was $18.9 million for the quarter ended March 31, 2013, $5.1 million more than the prior year quarter, reflecting our operating growth. On a cash basis, Q1 2013 capital spending was $61.7 million, which includes $35 million in costs accrued for in 2012, but paid in 2013 related to the new headquarters and research facility. We expect to spend approximately $125 million to $150 million in capital in 2013.

Approximately half of the planned capital spending is dedicated to new products and expansion initiatives, including the construction of the packaging systems facilities in China and India. Excluded from our capital spending guidance is $35 million for the new headquarters building.

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 March 31st was $175 million, $13 million higher than our December 2012 balance. A large majority of our cash is invested overseas and is generally not available to be repatriated to the US without incurring tax consequences. Debt at March 31st was $430 million, $18 million higher than at year end. A portion of the increase was due to the funding of our new headquarters and R&D facility. Our net debt to total invested capital ratio at quarter end was 25.5%, equal to the 2012 year-end ratio.

Working capital totaled $382 million at March 31, $86 million higher than at year end. $31 million of the increase was due to the refinancing notes that matured during the quarter on a long-term basis using our revolving credit facility.

Our backlog of committed orders stands at $373 million at March 2013, 16% better than at March 2012, excluding exchange effects, but as expected, sequentially only about 3% higher than December 2012 backlog. Based on our strong Q1 2013 results, and our analysis of the orders on hand we revised upwards our full year 2013 guidance in this morning’s release. That guidance is summarized on slide 12.

We have based our guidance on an exchange rate of $1.30 per euro. By contrast, our previous guidance was translated at $1.33 per euro rate. For the remainder of the year each one penny strengthening of the dollar versus the euro results in just over a $0.01 reduction of full year forecasted EPS as a result of translation. Slide 13 shows the significant factors that are expected to impact our margins in 2013.

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

Donald Morel

Thank you very much, Bill. This concludes our prepared remarks for this morning, and we now look forward to answering any questions. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator instructions) And your first question is from Arnold Ursaner at CJS Securities. Please go ahead Arnold.

Arnold Ursaner – CJS Securities

Hi, good morning.

Donald Morel

Hi, good morning Arnie.

Arnold Ursaner – CJS Securities

Don, I guess my first question relates to the margin year-over-year, last year in Q1 you highlighted you had an inventory build for a customer, you never quantified the revenue impact, but we are pretty aware that when you have an inventory build for a customer it can be a 25% incremental operating margin, so yet your high-value sales were up 11% year-over-year. If we were to exclude that one time inventory build for the customer, can you give us a better sense for what the actual growth would have been excluding that item?

Donald Morel

The actual growth Arnie would be still in that kind of – a couple of points less than that. So instead of the 6.6% we had in the packaging systems segment, it would be between one and two points less than that. But remember, the one point to remember Arnie is we have those kinds of situations happen every year in every quarter. We did have as you mentioned a launch of a customer’s new biologic [class] first quarter that stretched into the second.

But we have had, not as large, but we have had some of those similar kinds of things happen again this quarter. So to just pull out the launch last year would be somewhat of a misnomer.

Arnold Ursaner – CJS Securities

I’m sorry. Then I misunderstood you. Did you actually have a sizeable inventory build launch this year as well?

Donald Morel

No, no, no. None are [built], but we will have new products that are coming online as well.

William Federici

I think if you extract the impact of the build in Q1 of 2012, the revenue increase would actually look more favorable this quarter.

Arnold Ursaner – CJS Securities

I guess what I’m trying to say, let me try one more time, last year my perception was you had 8 million or 10 million of one-time revenue from an inventory build at very high margin. I am thinking that 2.35 you have last year on an adjusted basis in packaging was probably more like 2.30, may be even less than that, the 2.50 relative to that is a much higher rate of growth?

William Federici

It wasn’t quite that high when that happened, yes.

Arnold Ursaner – CJS Securities

Okay. Let us see – just going back on the pharma delivery systems, you mentioned you had several thousand SmartDose units sold – that were sold for clinical trials, my perception is they go for about $40 or $50 per clip, and are at very high margin, is that the right way to think about that?

Donald Morel

The total sales are – when they are – the total sample is exactly that. It is in – and it is not quite $40 to $50, but it is $30 to $50 per unit.

Arnold Ursaner – CJS Securities

Okay.

William Federici

It is actually not in Q1.

Donald Morel

It is not in Q1 Arnie. So those numbers – the way you got to look at it is we have made the – actually sent the trial units over to the customer. So we will be recognizing that revenue over a period of time.

William Federici

But the recognition per unit that we ship will actually be in Q2.

Arnold Ursaner – CJS Securities

Got it. And my final question relates to Vetter building up their capacity, and you are building up your capacity to do the needed testing on various CZ? Can you update us on the status of that?

Donald Morel

Yes, basically we have got the line in [Robin’s board] up validated and Vetter is running that line dedicated to CZ. We have not had the second unit delivered yet, which will go into the Chicago facility. So if you would remember better, Chicago facility is really aimed at clinical trial volume to support activity here in the United States. So we have got roughly 5 million to 6 million units go into capacity off the line in Germany, and the line in Chicago should come on sometime in the late 2014, early 2015 timeframe.

Arnold Ursaner – CJS Securities

Okay. I guess one more real quick, your SG&A in 2012 in Q2 had the Analyst Day expense, you haven’t announced an Analyst Day for this year, I don’t know if you are planning to, but should we get the benefit of not having that in the comp year-over-year?

Donald Morel

Yes, it will be small, but you actually will get the benefit. The Q1 SG&A was driven by a couple of odd things. I mean you had the rise in the stock price and the impact on our variable incentive comp. The Venezuela thing hit us to the tune of about [700] in the other category. And we did have some expenses in advance of our global sales meeting that hits in the first quarter as well.

If you look at SG&A as a percent of sales, we expect that to decline through the rest of the year and by the end of the year, our overall SG&A growth will be less than our rate of sales growth.

Arnold Ursaner – CJS Securities

I will jump back. Thanks.

Donald Morel

Thanks.

William Federici

Thank you.

Operator

Thank you. We have another question for you. This one is from Ross Taylor, CL King. Please go ahead.

Ross Taylor – CL King

Hi, wondering if you could give any color on the clinical trial the just got under way for CZ, I mean any color as to when that trial might be completed, just timing or any other parameters.

Donald Morel

That trial is under way and covered by customer confidentiality.

William Federici

Confidentiality Ross prevents us from saying anymore.

Ross Taylor – CL King

Okay. I understand. And the CZ revenue from the cartridges that I think Bill mentioned in his prepared remarks, are those related to the clinical trial, or is that something different?

William Federici

It is different. It gets integrated into this micro system. But we realized very little margin out of that because it is actually done by our (inaudible) partners.

Ross Taylor – CL King

Okay, okay. And I may have missed it with some of your earlier remarks, but did inventory stocking have much impact on revenues in the quarter or is that pretty much over do you think at this point?

Donald Morel

We think it continues to help. We just can’t put our hands around the magnitude. You know, clearly we got a little bit of safety ordering going on in some of the high-value categories because of lead time. But it is difficult to quantify in total of that inventory building in any given quarter.

William Federici

I think, Ross, I mentioned the European business was up 10.3% excluding exchange. That had some of that inventory build due to a very long lead time situation over in Europe. So, you know, exact quantification, as you know, is very, very difficult for us, but there is some of that in there.

Ross Taylor – CL King

Okay, that helps, and my last question on slide 13 in the deck on your website, one of the bullet points you say that certain proprietary product sales expectation had higher risk, is that any change in your thinking or is that kind of status quo, you know, how you have been thinking the last few quarters?

Donald Morel

Yes, it is pretty much status quo. We are just trying to point out the fact that it is really difficult to predict the timing of some of these things. They are lumpy because once we deliver our end of the equation, it is fully up to the customer in terms of the timing of launch, the timing of trials et cetera.

Ross Taylor – CL King

Okay. All right. That is all my questions. Thank you.

Donald Morel

Thanks Ross.

William Federici

Thanks Ross.

Operator

Thank you. There is no further questions just at this moment in time. (Operator instructions) Okay, no further questions have come for you. So, I would now like to turn back to Don Morel for closing remarks. Please go ahead sir.

Donald Morel

Thank you very much everyone. We’re off to a good start, and we expect to keep quarter two in line with our quarter one based on our backlog, and look forward to updating you on our Q2 call in early August. Thank you.

Operator

Thank you ladies and gentlemen. That concludes your conference, and you may now disconnect and enjoy the rest of your day.

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