West Pharmaceutical Services Inc. (NYSE:WST)
UBS Global Healthcare Conference
May 22, 2013 11:00 AM ET
Donald Morel – Chief Executive Officer
William Federici – Chief Financial Officer
Good morning and welcome to the UBS Global Healthcare Conference. Evan (inaudible) from the banking team. Up next, we have Don Morel from West Pharmaceutical Services. After the presentation, there will be a breakout session in Carnegie West.
Thanks very much Evan and good morning everyone. Thanks to our host UBS for having us back once again at their healthcare conference.
Mike Anderson is walking around; he is our treasurer and IR contact. He has hard copies of the presentation if you would like to have one. He has got the copy of our Safe Harbor Statement as it pertains to forward looking statement that we may make during the course of this morning’s presentation. Also joining me is Bill Federici, our Chief Financial Officer.
So what we would like to do today is talk a little bit about the foundations in the company for our recent growth and what’s going to drive our growth for the future, talk a little bit about 2012 first quarter 2013, our outlook for the business and what’s going to drive it.
For those of you that may not be familiar with the West story, we celebrated our 90th year in operations in April of this year. Fundamentally, the company was started as a manufacturing company, looking at different types of products for the dental market when Herman West founded it and since that time has grown to be the world’s largest and leading provider of components that go into injectible drug delivery.
We are fortunate to enjoy a tremendously stable and very differentiated customer base. All of the world’s vertically integrated research and manufacturing pharmaceutical companies are customers of West. All of the major biotech companies, the generic companies and the major medical device companies.
So our revenues are driven by a single customer. BD has historically been the largest. They are somewhere about 7% of revenue and within our top 10 you've got a very nice spread between the kind of $30 million and $55 million mark. So very nice geographic and customer spread of the business.
2012 was a record year for the company. Revenues were just slightly north of $1.2 billion for the year. We operate two divisions, one the historical West packaging business. We call this Packing Systems. This part of the business manufactures components that go into small volume drug packaging, disposable syringes, components that go into IV infusion sets and products that are used in the dental diagnostic and veterinary markets, all just part of our business, just north of 900 million in sales.
The Delivery Systems Group is about a third of our business $350 million. This is the group that does contract manufacturing of devices as well as manufacturing of proprietary West system, tends to focus on systems that are used for reconstitution of lyophilized drugs as well as some of the newer products that were in the process of launching which we'll talk about in just a second.
It's important to note that one of the key competitive advantages in our Packaging System Business is that we specced into the customer’s products when their drug application goes to the pertinent regulatory authority, very high switching cost in this business. They are required to do two years of stability testing to prove that the drug is indeed stable with our packaging components and that test data actually becomes part of their drug application.
Within the FDA, West Drug Master File 1546 the single most referenced document within the FDA’s archive. This document contains our proprietary information on our materials and on our processing methods. The FDA must write a letter asking West for a permission to review that document each and every time one of our customers puts a new drug application into the queue.
The other advantage we have versus our competition is our global footprint. We are the only ones in this space that truly manufacture globally as well as offering technical customer support and regulatory support in all of the world’s major markets.
On the delivery systems side, it's our expertise in engineering and high speed assembly of complex systems that sets us apart along with a broad portfolio of proprietary devices and as you can see from the bar chart, both of the divisions have grown very nicely over the last couple of years.
So the outlook for the markets depending on where you're located is either relatively flat to slow growing or very quickly growing as it pertains to India and China. We enjoy market shares in our primary businesses of about 70% in North America and Europe, but volume growth rates for our customers are not that high in these markets. Typically, they're going to be a couple of percent in mid-single digits.
What's interesting about our business is, that on the packaging side we don't necessarily need volume growth to drive our revenues. The strategy is built upon putting extra revenue into each unit that we sell so that our customers don't have to do that processing in their operation, freeing up capital and expense money to go into R&D and new product development.
In India and China it should be opposite. Volume will drive our growth there, although it’s driven by us following our multinational customers and continuing to package their products as opposed to selling into the local markets.
Injectables are an interesting space. It is the fastest and the best way to get a molecule into the body for therapeutic action. You avoid the liver which tends to take a lot of oral medications out in terms of their concentration and it's the best way to get biologics into the blood stream. So we enjoy a very strong position in the biologics market. Certainly if you look at the top twenty selling biologic drugs West packages all of them except for one.
We tend to benefit when the regulatory environment gets a little tight. You can hardly pick up a newspaper without reading about FDA issues at a number of producers' plants. What we try to do with our product offerings is make sure that during the manufacturing part of their process there are no packaging variables that enter into that equation, but the FDA is getting better and better at analyzing drug samples, better and better at identifying impurities. This in turn is creating a market push for cleaner and better products on the packaging front, and this is an area where we have a very-very strong position.
The other major trend is that you're seeing a lot of combination devices being launched. These are products where the drug is actually integrated into a device and the product is the combination of the device and the drug, not necessarily the drug or the device individually. And really it's been driven by the need for driving cost out of the healthcare system by having the patient take greater control of their dosing regimen, eliminating the healthcare provider as part of the delivery chain.
So as we look at our growth and we tend to plan in five year periods, within packaging systems, there's only three things that have to happen for us to execute well. One is continuing growth within our high value product segment. These products typically are used on biologic, high value oncologics and drugs of that nature. This is going to drive not only our revenues but our margin.
We are expanding in China and India. We are currently finishing up our second plant in China. I'll talk about that in just a minute, we are under construction in India as well as from expansion in key areas in the United States and we have to operate in the most efficient manner possible.
One of the things that goes along with the regulatory environment we operate in and the restrictions I talked about in terms of the customer referencing West, is that sometimes our facilities tend to be referenced in the master file as well. So we have a very broad manufacturing footprint for a company of our size with 38 facilities worldwide, can be a complex entity to operate but we think we can drive a lot of efficiencies out of our system.
On the delivery systems side it's the commercialization of the novel plastic resin for high value drugs that we call Crystal Zenith developed by our Daikyo Partners continuing to grow our safety and re constitution franchise and then introducing new devices into this combination product market.
So, if you take a look at our packaging business in a way that it falls out, the bubbles represent the relative revenue size of that $915 million business. The smallest bubble is what we call disposable medical components. This is a relatively flat market and it is not regulated in the way that the drug markets are regulated, tends to be disposable syringe plunger tips, components for diagnostic applications, components for disposable infusion sets. Business is about a $100 million relatively flat gross; relatively well gross margin.
The larger bubble just at that right of that is what we call standard pharmaceutical packaging. That bubble is roughly about $350 million to $400 million. That's comprised of products that go into the lower value drug, the standard generic antibiotics vaccines, large volume products of that nature; dental and veterinary applications as well. This drives gross margins on the order about 30 to 35%.
The key thing that's happening in our market is that bubble is shrinking and it's being driven into the green bubble in the upper right hand quadrant. That bubble represents our high value product franchise.
NovaPure, WestStar (ph), nVision, what we do is typically take our standard product and we can produce products with a series of attribute that make it better. One we can coat it, we can make it a barrier coating, we can have it go through vision inspection system to make sure there is no particulate and we can provide what are called certificates of compliance from our laboratories stating that the product meets its specification. All of these take costs out of our customers area and we can sell that product with a much higher margin.
Typically that bubble is about a $350 million bubble, growing in double digits and producing margins north of 50%. But the key for the next five years is that the standard bubble is shrinking. All of those sales are going into the upper right hand bubble depending on the attributes the customer desires in his product.
A similar phenomenon that's happening in our delivery systems business, it is primarily contract manufacturing at the current time. At the start of the year that spilt was roughly 80%-20% contracts are proprietary for West. That bubble is also going to shrink. It's going to move to the upper right in the propriety area and you can see what happens to your margin. The contract business where we do not own the intellectual property, typically is in the 18% to 20% range. On the propriety side, these margins are typically north of 40%.
Within our five year planning horizon, our goal is to get that spilt from roughly 80%-20% contract of proprietary, driving it to roughly 50%-50% where we have an even spilt and we are well on our way.
I talked a little bit about our geographic expansion and packaging earlier. We have been operating in China and India both for more than 25 years. Growth in those products has necessitated us, expanding our manufacturing footprint but unlike many companies this is not a reduced cost play for us. It simply is a supply chain play given our customers building capacity within both of those regions.
Our China plant for rubber is finished. We expect that to begin commercial production in the later part of this quarter. We are currently doing the sampling and validation runs that are required for our customers to approve that site for taking commercial product. In India, we will begin selling metal overseas in 2014. It will be a hybrid plant. We expect that to come online for our customers sometime in the early 2015 time frame.
Both of this are necessary to support growth in the region but also to take the burden off of our Singapore plant which is one of our more advanced plans. Singapore will be expanding its capacity to become the Asia Pacific source for high value products in the future. So good growth story they from a geographic standpoint.
If you talk about our growth strategy, it’s built upon those two platforms that I talked about with regard to packaging and delivery, but it’s also shipping the mix of our business from being a component supplier to an integrated system supplier and the reason that’s key is that when we look to the future, glass has been used in the pharmaceutical industry for many, many years.
Everything is set up to run glass at high speeds with our customers, but with some of the biologic drugs in the marketplace today, some of the more aggressive drugs that are used in oncology, it turns out that glass is not the best packaging material you can use. There are a number of issues with the drugs interacting with the glass, with de-lamination, with particulate; and in some cases with breakage during manufacturing or once the product gets to the market.
Out Japanese partner Daikyo has been developing a novel resin CZ that can be utilized in a number of applications for high value drugs. And the advantages are that it can be molded into a number of complex configurations. The system can be made completely silicone-oil-free. Many systems currently on the market, especially syringes now use a small amount of silicone oil to make sure the plunger moves in the barrel.
What these systems do is utilize a proprietary coating that is molded on to the plunger tip and eliminates the need for silicone. At the same time the way the needle is placed into the syringe does not require any glue. So we have eliminated virtually any potential for contamination from the sources that are typically found in a glass syringe. It has much higher break resistance than does glass.
Clearly we think this product is going to be a big seller in the future. It will take some time. The industry is very conservative. The 1 mL syringe now will a stake needle as in its first human clinical trial. Our Japanese partner sell about $15 million of this product into the Japanese markets, and right now zometa, a drug for osteoporosis is packaged in a CZ vial. We think all of these attributes are going to contribute to this being a very substantial product for us in the future.
The other thing it does is allow us to make containers with relatively novel geometries that can go into either auto-injectors, which would be a standard 1 mL syringe in most cases or into what are called patch pumps or large volume injection platform. For the last couple of years since acquiring an Israeli company, we have been developing this patch pump for the administration of drugs in volumes greater than about 1.5 mL.
The nice thing about this system is it uses an electrical-mechanical pump with a cartridge that can be anywhere between 1.5 mL and 5 mL, that’s programmable to deliver the drug subcutaneously over a period of half an hour to three hours depending on whatever the customer needs to achieve the therapeutic end results. It can be administered by the patient. They simply pull the packing off of the system, they put it on their abdomen, they push the blue button, the drug is administered over time, it beeps when the dosage is done and then it’s simply disposed of.
Tremendous interest in this because of the flexibility it provides our customers when they look at how they are going to formulate their drugs. Very excited about this product. It also will enter its first large scale human trial in the third quarter of this year.
With that it’s a pleasure to introduce Bill Federici who walk you through our 2012 numbers and our Q1 2013, Bill?
Thank you Don, and good morning everyone. Just spend a few minutes on highlighting our 2012 performance in the first quarter that we just released a few weeks ago. As Don mentioned the sales growth in 2012 was just over 10% to just under $1.3 billion. The big drivers of the sales increase was pricing initiatives by our business units to our customers and also the mix shift Don showed you in that chart with the bubbles on it, as our customers go up the quality scale towards that green bubble on the right we’re able to charge them more dollar per attribute that we’re adding to the products.
So that’s standard product that Don showed you which sells for $30 to $40 per thousand units when we apply the special coatings, we apply the West R processing washing, the Vision inspection on those products and special bagging in clean room environments, now those products same products will sell for $300 to $350 per thousand and the margin goes from the kind of 30% range up to the 50% plus, as we saw in that chart.
So that’s the driver of the sales growth, that mix shift along with a decent amount of pricing. Gross margins increased 210 basis points over 2011, again driven by the favorable mix of product sold the pricing initiatives and lean initiatives.
In 2012, we also brought back nearly all of our convertible debt that was outstanding and that has an accretive effect. The way the accounting works for those instruments as we had included the underlying shares that’s been outstanding in our EPS calculations. So buying back those converts reduced 2.9 million shares out of the equation.
We completed the construction of the second China facility as Don mentioned and have commenced construction of our India facility. All of our results, the favorable sales mix, favorable mix shift towards the high value products plus our lean initiatives more than offset or increasing costs and we’re able to put up a 25% increase in EPS in 2012 versus ’11.
Few weeks ago we released our first quarter results. Again strong sales growth of 7.2% excluding currency just to $339 million. Again the sales increase was due to more modest pricing initiatives but continued mix shift towards our high value products that we talked about. That favorable mix shift along with lean efficiencies again more than offset cost and we were able to increase our gross margins by 100 basis points to 32.9%. So, again favorable output of EPS $0.87 on a non-GAAP basis versus $0.83 for the first quarter of 2012.
Looking forward 2013 expectation, we lined them out for everybody in our earnings release for the first quarter. We continue to see this high value product striving growth. That mix shift is very, very important to the packaging systems business.
We’ll continue to see modest pricing increases versus 2012. The customers who had depleted inventory levels back in the 2008 through 2010 timeframe have been rebuilding those inventories. We’ve seen that as part of the very high growth that you saw in 2012 that continues a little bit into 2013. We’re not exactly not sure when that ends but it’s certainly something that we are keeping our eyes on, it has a favorable impact.
Lead times and backlog, our backlog continues to be very strong. Our backlog committed orders continues to growth over the same time in the prior year. It’s double digits growth still. However, when you look at it sequentially compared to the end of the year it’s only growing about 3%.
New facilities, we talked about China and India. The new facilities will actually cost us on the margin line as we ramp-up those facilities, you have start-up costs associated with that. Those start-up costs dropped at a bottom-line because there is not a lot of activity going on in those plants at this point. Exchange rate, commodity and share price all have impacts on our 2013 expectations that were lined out for you in our earnings release.
Longer-term, the packaging business will continue to grow based on this performance of high value products and the continued mix shift driven by both customers and the regulators. Lean productivity gains, we have each of our plants in our global system as lean targets for each year established at the beginning of the year and they are monitored throughout the year. That is a very substantial part of the story of being able to offset the increase in inflationary cost in labor and material and overheads.
We have to figure out, Don talked about the China facility coming online in the second quarter and India coming online in a phased approach in 2014 and 2015. Those facilities and the uptake of those facilities will be key to the profitability in a long-term basis. Albeit off a very small base today, we do expect those sales to continue to grow in the solid double-digits going forward.
Commercialization, the proprietary part of our Delivery Systems business, the two products that Don talked about primarily, CZ and SmartDose are figured very favorable into our growth plans for the longer part of the back part of our five year planning horizon. Not so much sales today, there are only modest sales in the $10 million to $12 million range but as we get out to the back part of our five year plan these types of products can generate significant sales and profitability for the business.
With that said I would like to turn it back over to Don for some closing comments.
Thanks very much Bill. I think the takeaways we would like to leave you with, our understanding that within the packaging business we are designed into the products in a way that regulatory barriers work. There are extraordinarily high barriers to switching. We have been able to maintain tremendous market shares in this business and it is a key focal point for management in the future.
A lot of our investments on the capital side are not only aimed at capacity, but quality question, putting the Vision, the clean rooms and all of that into our operating facilities for those high value products which is the fastest growing part of our product portfolio and the one that drives the margins.
We are well positioned for growth in the emerging markets in Asia. New plants will be coming online over the next couple of years to meet that capacity. We enjoy a very strong balance sheet. Our net debt to total capital tends to stay in the 25% range. We are in the midst of a capital cycle clearly and expect those expenditures to be somewhere in the $120 million to $150 million range for the next couple of years. Support maintenance, large part for new products and expansion as well as investments in IT to help run the global enterprise.
You've have got a terrific management teams, very long in the tube. Bill’s been with us 10 years, Mike and I 20. The broader part of our operations team all have more than 20 years of experience and the way that our incentive programs work, we focus on capital efficiency, management for the long-term and incentivize on a combination of not only revenue growth over a three years cycle period but also return on invested capital.
We do pay a very, very nice dividend which we have been able to increase consecutively over the last 20 years as well. So good picture for us, great growth prospects, very encouraged by what we see in the markets and we would be pleased to answer any questions you have in the breakout session. Thanks very much for your time this morning.
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