Call Start: 10:35
Call End: 11:05
West Pharmaceutical Services Inc. (NYSE:WST)
Morgan Stanley Healthcare Conference
September 11, 2013 10:35 AM ET
Don Morel Jr. - CEO
William Federici - CFO
Hi good morning, my name [indiscernible] Ricky Goldwasser in the Healthcare Services Group and I am happy to have West Pharmaceutical Services with us. With us here this morning, we have Don Morel Jr., CEO; and William Federici, CFO, from West Pharmaceutical. So maybe feel free to jump in with questions anytime raise your hand, we would love to assess as many as we can and maybe we can start off Don and Bill with an overview of the company for those who might not be familiar with us.
Don Morel Jr.
Great, it’s our first time here at Morgan Stanley, so I like to extend the thanks to them for the invitation to participate this year. Mike Anderson, our Treasurer and Investor Relations contact of the copy of what traditionally would be our background presentation. I hope you like the copies as the flag come down. For those who may not be familiar with the West story, we just celebrated our 90th year of operations. We’re based on Pennsylvania. We are principally a manufacturer and developer of packing systems and administration systems for injectable drugs. We also have a small consumers operation. We do some contract services work for our customers as well but predominately our business is focused on small volume injectable drugs.
We operate two divisions. The first division is our traditional packaging group, pharmaceutical packaging system as we call it, that’s roughly about $1 billion worth of revenue this year. The second is what we call pharmaceutical delivery system and this is the group that is focused on the development and manufacturing with sample devices and systems for reconstitution, safety and drug delivery. We are very fortunate our customer base is quite diversified. We serve every major vertically intergraded pharma company around the globe, all of the generic, all of the biologic manufacturers and a very high percentage of the large medical device manufacturers as well.
We don’t have a high revenue concentration in any particular area biggest customer is BD currently roughly about 7% of revenues. We’re split on the revenue basis between Europe, United States, and the rest of the world roughly about 50, 40, and 10 in terms of the distribution of our sales. Our manufacturing footprint is quite complicated. We operate 35 facilities worldwide with a tendency to source and service our customers locally where we can although that model is changing quite a bit. One of the challenges we’re facing is that the point of order now is not necessarily equal the point of consumption, so products are moving around quite a bit between Asia, Europe, and the United States.
Our growth is driven really by couple of key therapeutic categories, we’re a major player in diabetes we serve Novo, Lilly and Sanofi. Packing virtually all of the world’s injectable insulin, little tiny device of 3 ml cartridge that goes into the pen sets as well as vial insulin with very-very strong and biologics packing, the top 20 biologic drugs that are sold we package all of them, very strong franchise there, very strong franchise in vaccine and biologics for autoimmune disease and also generics.
Couple a of key takeaways about our business that are kind of interesting, we are essentially specified into the customers product from the outset so there are very strong regulatory barriers to entry in our core business. We enjoy about 65% to 70% market share in those businesses between Western Europe and the United States not so high in the med device side probably about 60% with our major customers little bit smaller in Asia because the competitor picture is different but when a customer goes to market with a new drug they have to prove stability with the package, they test our components and contact with their drug for a period of two years that data becomes part of their submission to the FDA and effectively once the product goes to market the testing is done, FDA gives approval for marketing of the drug.
We inspect into product and this is an example of stickiness of our business. We still produce products today that were developed by our founder Herman West back in 1930s, relatively small volume drugs but because they’re in the drug application for the customer, we are the producer and interesting side notice that our most valuable piece of intellectual property resides within the FDA it’s called the Drug Master File, it is the single most reference document within the FDA’s achieves, all of our proprietary data is in there when it comes to the composition of the closures that are in contact with the drug, so we think we’ve got really nice growth story and strategy.
Growth this year has been fairly solid, high single digits. Bill will run you through the financials in just a second but principally our strategy is really quite simple, it is value added sales through the packing systems group for high value drug operating efficiently within our facilities and geographic expansion into India and China. On the device side, we are simply shifting the percentage of sales of our products from about 80% customer oriented now 20% proprietary to about 50-50 proprietary mix over the next five years.
We have got a really nice portfolio products ranging from auto-injectors to large volume infusers that we think are going to drive that growth along with organic growth within our core packaging business, so that’s kind of a snapshot of where we’re at. Bill maybe you can talk a little about the year and where we are.
For the six months, we are tracking about little over 6% ahead of where we were last year, growth in both divisions is around that same number, margins are expanding nicely driven by two things that Don hit on, the first one in the packing system side is a migration towards what we call high value products. One of the beauties of this business on the core manufacturing of component side is that we don’t have to rely on lot of volume to continue to grow the business. What we have is we have, Don mentioned, the high market shares in biologics. Those biologics tend to use a very, very high quality packaging for the primary packaging components which allows us to up-charge the customer for a lot of downstream services such as washing the product, using vision systems to reduce the level of particulate on the product and bagging off and finishing the product in a clean room environment. All of those added attributes allow us to up-charge the customer for that very same unit product.
So when we look at our growth rates, our growth rates are actually ahead. When you look at the underlying markets that we serve in an aggregated basis, we are growing faster than the markets we serve on the primary component side. On the delivery system side the growth is really all about as Don said migration between our contract manufacturing business and our proprietary group of products. We continue to grow its awful small base on the device side but proprietary business as he said is projected to grow nicely over the next several years. Really the margin growth in that side of the business today is a little bit of mix selling those high value proprietary protected products but also a lot of lien efficiency in our contract manufacturing plants.
Our balance sheet is very strong. We have about $175 million worth of cash at the end of the second quarter, a lot of that invested overseas and as obviously some tax consequences bringing it back but that’s where a lot of our growth is coming from so it’s well matched there. In terms of leverage ratio, we’re very over less than 25% on a net debt to total invested capital basis. We have nice operating cash flows that are driven off the business that are used to invest back into the business. We have a high level of capital expenditures that we put into the business as we continuing to grow and we pay dividend each year.
That’s a very high level snapshot of the financials. If anything else you wanted to add or we can turn it over to questions.
Don Morel Jr.
No, to the questions.
Okay, thank you. Why don’t we start in the part of the [indiscernible] cash influences that both touched on growth and there is a few healthcare things happening in your favor over the next few years, I was just wondering if you could talk about, so we’ve got Healthcare Reform coming which should increase volumes which should help both drug volumes just curious your thoughts on that as well as all projections are in biologics becoming five of the top ten, eight of the top ten drugs over the next five to 10 years, which seems to work in your favor from both the margin perspective less for the volume but more of a margin benefit perspective. How are you guys thinking about that long term growth rates compared to the high single digits now over the next several year without giving guidance?
Don Morel Jr.
As we’ve talked about the growth rates staying in the core business and that kind of 5 to 7 range. And you’re absolutely right assuming that the ACA remains intact in large part as traditional people come in, the traditional vaccinations, standard antibiotics all of those kinds of things just greater access on diagnostic side will help us. Probably the biggest thing for us is the demographic question with an aging population in Western Europe and United States and lifestyle changes in China and India is that insulin has been and diabetes is a category has been a very strong driver for us. I mean obviously there is societal implications but from a business standpoint we expect that category to be a very nice driver for the foreseeable future.
As people live longer, as cancer becomes more of a chronic disease and is treated over a lifetime that benefits us many of the top selling biologics now if you take things like [indiscernible] lifestyle related arthritis diseases things like that for the chronic that absolutely benefits us. So when we look at the drivers therapeutically, it is diabetes it’s oncology, it’s autoimmune, its vaccines and its generic injectables, so all of those things work in our favor.
If you look at the FDA’s pipeline was coming through clearly over the last couple of years there has been a fairly substantial shift from small molecule to large molecule. Many of the traditional small molecule players have acquired were looked at ways that they can get into large molecules. We see that trend continuing lot of great things and Phase 2, Phase 3 coming to on the biologic side, all of which we’re on in terms of the stability in future packaging, so all of those things augur well for the packaging group.
Great, the other side of that thinking of pricing, so you’ve seen tremendous inflation over the last several years on brands and biologics and then pharmaceutical pricing, how is that impacted your pricing? Have you seen any of that as price inflates or has your prices stay pretty stable over that time period?
Don Morel Jr.
Our pricing has been fairly solid in kind of the 1% to 2%, 2% to 3% aggregate range over the total business. Last year we enjoyed a bit more of a price increase really because of timing one of our major raw materials is oil and many of our contracts are based off of price of crude. We have a bit of a four months lag between when we get the benefit or when we see the negative aspects of it. But pricing for us has been fairly consistent and fairly solid. The one thing about our business we have to watch it with because of the regulatory aspect, we do have considerable pricing ability but you have balance that all against access to future programs. It’s a little bit of challenge of time.
And your new expansion in emerging market how does that price mix affect to you?
Don Morel Jr.
Our emerging market strategy is really built off following the multinationals right now. So, penetration of the local and digital market for specially in China and India against the local producers is not something that we’re aggressively producing, we preferred few select brand at the high quality bar and focused on the very high quality branded medicines.
And maybe while we’re sticking to emerging market, I believe you’re expanding capacity recently in India and China, how is that going on and are you thinking of expanding further in those markets?
Don Morel Jr.
I believe we’ve got one plant already that came online in 2009 in China that was a plastic manufacturing facility makes IV fitments for ($1) in the IV space. That has going very well. This past year we completed the construction of our second facility in China which is a rubber’s facility. That’s, basically at the end of the second quarter was ready for commercial production and we started commercial production.
India, we have a, our first entrée into India as a manufacturer. We put the spade in the ground and we’re hoping to complete the metals facility which is the first tranche of building into India by middle of 2014 and a rubbers facility that will come on after that.
So, all doing very well; Tom mentioned we’re selling to through the multinationals mostly into India and China. It’s a small business for us this point in time. It’s still only sub 50 million in total but we have, it’s been growing very nicely double digits and we’ll continue to do so. We’ve been selling into India and China for a very long time using our Singapore facility as the manufacturer. So these are very important plans for us to continue to help and support our multinational customers as we go forward.
And as you’re thinking about partnering with these customers, I’m just curious, at what phase of development you start interacting with them because especially to get into the biologics accelerate system gets very important pretty quickly but is it phase III, phase, at what point actually really start working at the pipeline and try to understand where you’re products are going to coming in.
It actually starts earlier; when a new product is going to market, the format traditionally has been in a while and we are in from the get go there so with the smaller guys that don’t have products on the market we get in early, we provide free samples in the preclinical period. We help them think through many of the questions and packing that they probably aren’t focused they’re worried about getting molecule on the clinical trial.
By and large, the packaging is fixed at about phase II and it has to be fixed phase III. So, once they go into the final stage of the clinical trials, the packaging is used on the drug has been through stability and through the large part is going to be (specked) in when they go their drug application.
The change for us in the marketplace is that on the packaging side of the business we will start components across the therapeutic categories. So if there are five participants in array for example and will stock components to all of them.
As they begin to look at large cycle planning and their products are move from a while into a prefilled syringe, into an auto injector and in delivery format; that’s a bit of a different story because they are going to want exclusivity for that therapeutic category. And that strategy is wholly dependent on the customer.
There are some at the advent of phase I and II are thinking of that in natural progression of the product, looking at an auto injector two years post launch looking at a patch pumped five years after launch. All of those things are already briefed in.
There are some ways we have the market evolved and as it evolves and they see people preferentially either don’t mind using a prefilled syringe or the docs prefer or nurses prefer prefilled syringe or as we get more and more to home administration to drive our cost as Bill mentioned simple systems that are simple, safe, dosing volumes can be accurately done, it can easily disposed off.
Then the trials become more human factor trials and companies look at us to help design that in. So, we become involved a little bit later in the process.
That is an interesting question, as you are partnering especially this earlier stage companies may not have a, definitely have the experience that you do. How much of investment and R&D and time and how does that impact your SG&A as you’re working with these companies and especially as we’re seeing more and more new compounds coming from these smaller companies?
It doesn’t impact SG&A budget a great deal. The products that we traditionally produce, we produce in the billion and that includes a very high values, components that Bill talked about that have a flow [indiscernible] are washed in a special way, go through vision and inspection before final quality. So, to provide them with 5,000 or 10,000 components as they go through their work is virtually no cost to us.
The important part is the time that has to be spent with the developers and the formulators so that they understand their factors that we’ve the good container closer integrity and more importantly container formulation compatibility. But one thing you need avoid at all costs are contaminants from extractable and (reachable) in the packaging or any extraneous material that enters into the drug formulation either from particulate on the surface of the stopper or something during the process.
So it’s getting them to shift away from the molecule and as Bill said, educate them as to everything that the FDA will be looking for as part of their drug application.
And you work with them when the FDA is going through their?
Yes, hand in hand.
Okay, great. Is there any question?
[Indiscernible], what is the current penetration and what do you expect [Indiscernible]
Sure, Crystal Zenith resin was developed by our Daikyo partners; it’s a novel (NYSE:CLP) plastic system that really is targeted at high end biologics. And the biologic space there have been a number of issues recently with glass contamination, glass flaking, breakage of the glass inside auto-injectors and a number of compatibility issues.
So it’s not going to happen overnight but many in the market believe there's going to be a subtle shift that will pick up speed in the future converting very high end products out of the traditional glass syringe into a ACZ or another plastic syringe. What makes the West system unique is that we can combine it with a floor polymer [indiscernible] plunger which with the IP on to provide a silicon free system.
One of the issues has traditionally been contamination of the drug substance with silicon that is used to make the plunger and the prefilled syringe slide easily up and down the barrel.
So there are a number of the issues that the plastic solves. In Japan we sell about $50 million now, it's significantly penetrated and things like high uronic acid, calcitonin and human growth hormone, but also has a substantial share in diagnostic imaging, large volume syringes for contrast agents, not so much in the United States and in Europe, there is one product in while now is Zometa there are large number of molecules that have gone through pre stability testing, over a hundred we believe, and four or five that are currently in formal stability testing as well.
We talked long term about our aspirational goals for CZ, the addressable market is probably about 600 million and I'll concentrate on prefills right now, that go into the high valued biologics market, that is growing anywhere from an 8% to 12% kind of range depending on therapeutic category.
That market is wholly addressable out of the two billion total syringes. Our penetration assumptions are modest at roughly 5% in the early years which we believe will be in the late 2015, early 2016 time frame and then moving out. What we are looking for is CZ sales moving at a current value of between 10 and 15 million in the U.S.; all of that for clinical testing samples for line trials with our customers, somewhere into the $200 million range by the end of 2017 beginning of 2018.
The one caveat there is that we do not control the timing of the submissions to the FDA and we do not control the construct of the dossier and how the data post stability is put together by our customer although we help them with that. So once they complete the testing it's wholly out of our hands.
Any other question?
Great so, [indiscernible] delivery systems and proprietary products and you mentioned next going to 50-50 over the next several years [indiscernible] product. In addition to the CZ, what other products excite you on the proprietary side?
CZ is a category, as Don mentioned it’s a polymer that's used in multiple applications, over the life cycle of the entire drug so you can have a bulk container that has, uses CZ all the way down through auto-injectors and patch pump systems etc.
Some of the things that excite us, like, we do have commercial product right now, that category of our proprietary products and delivery systems side is approaching $100 million this year. There's a significant amount that is in fluid transfer devices, so needleless transfer systems, we bought a company in 2005 called Medimob that was one of the innovators of using collars and various blower attachments to allow for the reconstitution and transfer of freeze dried and other drugs without the use of a needle.
So that from a safety perspective we all know what’s going on in the healthcare system. You can think about a hemophiliac who has to worry about needle sticks or certainly in care environments where you're working, nurses are working with needles all the time. These are systems that allow you to be able to either reconstitute Lyophilized or move drug from one platform to another, without the need of a needle.
We sell about $50 million of those products today; we have safety systems that are very exciting to us. You know we own a proprietary spot; we have one solution for a specific customer that's generating about $20 million of safety systems today but we see that as being again due to the regulatory nature and needle sticks etc, we see that as being a growing part of our business going forward.
Don talked heavily about CZ and its import to us in the future as a platform but the things that go around that, whether it be a prefilled syringe or an auto-injector or a patch pump system are all exciting opportunities for West in the proprietary space that we think will continue to grow. And as you try to move care out of the critical care settings into patients hands it's pretty easy when it's a pill situation, when it's a dry drug or otherwise biologic or a toxic drug, those are very, very difficult to do in this kind of a format.
So having systems, prefilled systems or auto injectors or patch systems that allow you to have safe efficient easy to use and accurate systems that allow the patient to self administer or administer in a clinical environment. You can see the natural savings of cost in the entire system Very exciting times for West; lot's of opportunity in those spaces.
Don Morel Jr.
The only thing I would add to that is if you look longer term in our space, the logic behind the strategy moving components to system is built upon what we see as a major trend in the delivery device and the primary container actually become made it historically, everything was administered bedside, the nurse, the doc, we drew the medicine from the vial of the syringe and then administered directly to the patient. What's happening now is that with things like auto-injectors for RA and other diseases is being administered by the patients and the dose is automatic and the container is integrated into the device.
So if you look at how that strategy has evolved for us for the last five of seven years have been really focused on building a portfolio of options for our customers that we can work with them to customize for their particular needs. The best example is the SmartDose system, this is a small abdominal patch bump, the patient puts in on their abdomen much like a band aid, activates it and then over whatever period of time is appropriate for the drug, you deliver (bonus) dose greater than 1 ml subcutaneously; they remove it and dispose it.
As part of our second quarter conference call we announced our first feel for that received a $20 million exclusivity fee, the customer and the molecule and the indication unfortunately are confidential but I think it indicates the direction the market was going and the confidence that our customers have in the technology platform.
So all of those things come together from owning, at the interface of the drug and the primary container to utilizing CZ as a primary container and multiple configurations and having that integrated into final delivery system.
We still have time for one more question from the audience. If not I am going to ask one financial question, that's just about backlog. So if you look year over year your backlog, your backlog is down a little bit. Can you just talk about the dynamics of that and also your backlog and your orders give you any insight into overall utilization or is it just too much in between the end?
Don Morel Jr.
I will answer the last question first; yes it is our best leading indicator. However, it’s not perfect for two reasons. One it only comprises about 85% of the next quarter's sales but they are firm orders to be in our backlog, it's not something that's taken away, it's just the timing has some movement in it.
There are number of factors that have caused our backlog to be where it is. You think since 2008 when with the financial crisis a lot of the customers started to collapse down the amount of inventory they held of all their suppliers including West, to the point where we thought they got a little too lean in 2010, 2011 right after the Fukushima accident, we had a lot of companies that are our customers think about the risk side of that profile and say gee, our components are primary components sell for hundreds of dollars per thousand, so you can start to think we manufacture 36 billion things a year.
So you can see as it relates to a very high price drug there is not a lot of cost on holding our products. So inventories have started to expand, at the same time we saw our lead times and have plants expanding, so customers were adding orders on top of orders.
We have done a lot of work internally to reduce the lead times which has had the impact of having customers now not need to have all those extra orders plus they are at the backside of their building back their inventory levels to more normalized levels, we see the backlog as an indicator, we see it coming down to more normalized levels and being more of a predictor of real growth going forward.
And the last, just give us an idea what should we be looking at from what's over the next couple of quarters?
Don Morel Jr.
Q3 call typically takes place, I believe its November 1st at that time we update our revenue expectations for not only the forth coming year but also our five year planning cycle and we update on that. And then we provide detailed guidance as part of our February call.
For us, we have had a terrific year up to this point, after the strong 2012 this strategy is working we're going to stay with this strategy on the packaging side and we're going to emphasize getting more collaborative deals done on the device side and pushing the device part of the business. Do those two things and we’ll be in good shape.
The call is October 31st Mike is telling me at 9AM. Thank you Mike.
Thank you Don and thank you.
Don Morel Jr.
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