West Pharmaceutical Services' CEO Discusses Q1 2014 Results - Earnings Call Transcript

May. 1.14 | About: West Pharmaceutical (WST)

West Pharmaceutical Services Inc. (NYSE:WST)

Q1 2014 Earnings Conference Call

May 1, 2014 09:00 am ET

Executives

Don Morel – Chairman & Chief Executive Officer

Bill Federici – Senior Vice President & Chief Financial Officer

John Wollford – Westwicke Partners (NYSE:IR)

Analysts

Arnie Ursaner – CJS Securities

Rafael Tejada – Bank of America Merrill Lynch

Ross Taylor – CL King and Associates

Operator

Welcome to the West Pharmaceutical Services Q1 2014 Results Conference Call. (Operator instructions.) And now I’d like to 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 Q1 2014 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’ve 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 on the Investor tab under Presentation Materials 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’s 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 laws 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 adjusted 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’d like to turn the call over to Don Morel, West’s Chairman and CEO. Don?

Don Morel

Thank you, John, good morning everyone and welcome to West’s Q1 2014 Earnings Call. This morning Bill and I will review our results and discuss our outlook and financial guidance for the remainder of the year. We will again refer to a slide deck to support our prepared remarks that can be accessed through our website at www.westpharma.com under Investors. In the event you cannot access the presentation our commentary will cover the information both in this morning’s release and the slides.

Beginning with Slide 3 which summarizes our Q1 performance, a modest increase in sales coupled with a less-than-favorable mix in the Packaging Systems segment produced a softer start to the year than we would normally see. As we discussed in our February call this was not completely unexpected and we do not believe it reflects any fundamental change in the underlying drivers of our business.

On a consolidated basis sales rose 1.2% to $346.8 million excluding the effects of currency. Revenues were effectively flat in the Packaging Systems segment while sales increased 5.6% in the Delivery Systems segment driven primarily by demand for contract manufacturing services. The less than favorable mix produced a decline in our gross margin, leading to earnings of $0.38 per fully diluted share versus $0.44 in Q1 2013 which was a record year in all respects.

Highlights for the operating segments are shown on Slide 4. For the quarter, Packaging Systems sales of high-value products declined by a little over 6%, primarily as a result of reduced orders for Teflon and FluroTec enclosures. This was built into our full year operating plan given the substantial growth these product lines experienced throughout 2013. Our analysis of current order flows and the rapid increase in our Packaging Systems backlog through March gives us confidence that this issue is largely behind us.

In the Delivery Systems segment slight declines in sales of proprietary products like Safety, Reconstitution and CZ were more than offset by continued strength in the contract manufacturing business. CZ sales for the period were $3 million comprised mostly of vial and cartridge sales. Sales of the 1ml long Insert needle syringe were modest and are expected to be sporadic throughout the year depending on customer pre-commercial use for testing and validation requirements.

Despite the relatively slow start to the year we see no fundamental changes to the primary growth drivers of our business over the long term. For the next three quarters we expect our order book to steadily improve, leading to a strong finish for the year. Indeed as I mentioned earlier, our backlog strengthened substantially at the end of Q1, increasing 11% versus year-end levels. More importantly the composition of the backlog indicates that orders for high-value products are returning to historical patterns and we should see high-single to low-double digit growth through the end of the year.

Slide 5 provides highlights for ongoing expansion and development programs. Our new China elastomer plant is now operational and has started commercial sales. Work on the India seals plant has been completed and we have received our operating license for the local government authorities. On the development program front we continue to work closely with a number of customers to develop custom device solutions based on a broad array of West technologies including SmartDose and CZ.

As noted in our release this morning, pursuant to a development and supply agreement we are collaborating with Amgen on automated mini-dose systems utilizing West’s SmartDose Technology. Due to the confidential nature of our work with Amgen we will not be providing any further commentary other than what is in today’s release.

The 1 ml Insert needle syringe program is at a stage where orders will continue to fluctuate quarter-to-quarter as our lead customers have completed much of their qualification work. For those customers with formulations undergoing formal stability testing we continue to believe the lead candidates for commercialization will finish testing in the late 2015 or early 2016 timeframe.

Once this testing is complete the data can then be submitted to the appropriate regulatory agencies depending on the market where approval is being sought. On a positive note, the demand for CZ cartridges to support SmartDose testing and CZ vials for aggressive drugs continues to be healthy and in line with our expectations.

As summarized on Slide 6 we are confirming our guidance for the full year and believe sales growth will be in the range of 6% to 8% on a consolidated basis, yielding revenues between $1.45 billion and $1.48 billion. We are forecasting an improving mix through the end of the year driven by high-value product growth which should translate into stronger consolidated gross and operating margins yielding full-year adjusted earnings in the range of $1.77 to $1.89 at our assumed current exchange rates.

Our confidence in delivering solid sales and earnings growth for the full year is based on the positive changes in order flows at the end of the quarter, the composition of our backlog and the absence of any fundamental change in our underlying business drivers [or] market share.

Our strategy remains focused on expansion of our high-value product offerings, lean operations and selective organic growth in emerging markets for the Packaging segment; while shifting sales in the proprietary products group to a higher percentage of our overall sales for the DS division. We believe proprietary products as a percent of overall sales will continue to grow through 2014.

On a final note I’d also like to extend an invitation to attend our 2014 Investor Day on the morning of May 22nd which will be held at the Cornell Club in New York City. Details will be posted on our website in the next few days, however, for those who cannot attend the presentation will also be webcast.

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

Bill Federici

Thank you, Don, and good morning everyone. We issued our Q1 results this morning, reporting net income of $27.1 million or $0.38 per diluted share versus the $0.45 per diluted share we reported in Q1 2013. As explained in the release, excluding the effect of one-time items from the prior-year quarter our Q1 2013 earnings were $0.44 per adjusted diluted share. A reconciliation of those non-GAAP measures is provided on Slides 13 and 14.

Turning to sales, Slide 7 shows the components of our consolidated sales increase. Consolidated Q1 sales were $346.8 million, an increase of 1.2% over Q1 2013 sales excluding exchange. Packaging Systems sales were essentially flat versus the same quarter 2013 sales excluding exchange.

Sales price increases in Packaging Systems were limited to approximately 0.4 percentage points and were offset by an unfavorable mix of products sold with our high-value products declining 6.9% versus the prior year Q1. The decline in high-value products sales was not unexpected and we believe should be considered in the context of the double-digit growth experienced in each of the two last year comparable quarters benefiting from customer inventory builds.

Importantly, for the remainder of 2014 we expect an 8% to 12% growth in high-value products sales versus the comparable year period. Our current packaging systems backlog growth of 11% over the prior year is mostly due to an increase in committed high-value product orders. In short, we do not believe our Q1 results represent any change in the long-term growth trajectory for our business.

Delivery Systems sales increased by 5.6% or $4.9 million over sales in the prior-year quarter excluding exchange. Crystal Zenith product sales were $3 million in the current quarter, approximately $600,000 below Q1 2013 levels and were predominantly comprised of vial and cartridge samples. Overall sales of proprietary products were $21.0 million or 22.5% of the segment’s revenues in the quarter versus 25.0% in the prior-year quarter.

As provided on Slide 8 our consolidated gross profit margin for Q1 2014 was 30.7% versus the 32.9% margin we achieved in Q1 2013. Packaging Systems Q1 gross margin of 35.4% was 2.3 margin points lower than the 37.7% achieved in Q1 2013. The decline in the gross margin is due to the unfavorable mix from the lower HVP sales and lower plant utilization coupled with normal inflationary increases in labor and overhead costs, and the relative low price increases.

Delivery Systems Q1 gross margin declined by one margin point to 18.1% compared to the prior year quarter. The current quarter’s lower gross margin is primarily due to the decline in proprietary device sales and normal inflationary increases in labor and overhead costs.

As reflected on Slide 9, Q1 2014 consolidated SG&A expense decreased by $2.7 million versus the prior year quarter. As a percentage of sales, Q1 2014 SG&A expense was 16.2% versus 17.4% in Q1 2013. Pension costs declined by $1.9 million, benefiting from the strong return on plant assets in 2013.

Stock-based compensation and incentive costs were $1.3 million lower than a year ago primarily as a result of the decrease in our stock price during Q1 2014. Other compensation costs were $2.3 million higher including annual salary increases and increased staffing. Outside service costs were lower than the prior-year quarter.

Slide 10 shows our key cash flow metrics. Operating cash flow was $8.8 million for the quarter, $10.0 million less than the prior year quarter reflecting the decline in our results and higher working capital requirements. Our capital spending was $31.7 million in the current quarter.

We expect to spend approximately $125 million to $145 million in capital in 2014. Approximately half of the planned capital spending is dedicated to new products and expansion activities, including approximately $13 million for the construction of Packaging Systems facilities in China and India.

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 $230 million, equal to our December ’13 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 $404 million, $31.4 million higher than at year end. Our net debt to total invested capital ratio at quarter end was 15.8%. Working capital totaled $459 million at March 31st, $45 million higher than at year end. The majority of the increase is due to higher inventory and accounts receivables balances.

Our backlog of committed Packaging Systems orders stands at $351 million at March, 2014, 11% higher than at year end excluding exchange – but as expected about 5% lower than the March 2013 backlog which we attribute to our shorter lead times. At March 2014 high-value products represent 53% of the total backlog versus 49% of the December ’13 backlog.

Based on our Q1 2014 results and our analysis of the orders on hand we have narrowed our full-year 2014 earnings guidance in this morning’s release. That guidance is summarized on Slide 12. We have based our guidance on an exchange rate of $1.37 per Euro. By contrast, our previous guidance was translated at a $1.35 per Euro rate. As a reminder, each $0.01 weakening of the dollar versus the Euro results in an approximately $0.01 increase in full-year forecasted EPS as a result of translation.

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

Don Morel

Thank you very much, Bill. This concludes our commentary for this morning and we’d now be pleased to answer any questions. Operator?

Question-and-Answer Session

Operator

(Operator instructions.) The first question comes from Arnie Ursaner of CJS Securities.\

Arnie Ursaner – CJS Securities

Good morning. Focusing first on your backlog, your lead times had been running extraordinarily high – 22 to 24 weeks. You brought it down to around twelve weeks in Q4; is that about where we are now?

Don Morel

Yes.

Arnie Ursaner – CJS Securities

Okay. In Q4 you had mentioned two additional development agreements I believe for SmartDose. Is there any update you can provide on that?

Don Morel

The work is ongoing and we are producing samples for those clients.

Arnie Ursaner – CJS Securities

Okay. And then you also referred to some deferred projects that would add to contract manufacturing revenue. You can have some fairly sizable swings in margin depending on what these products are. Can you expand any more on the deferred projects and when you expect the revenue from that to hit?

Don Morel

The first project is online as we speak; we are doing validation and trial runs on the tooling. The second one will come into operation later in the year. We expect the first to contribute a good amount during the year; the second one a bit more modestly. So both of those should be up and running by Q3 or Q4.

Arnie Ursaner – CJS Securities

Okay, and I do have one final question if I can. In your prepared remarks regarding guidance you talk about $10 million to $20 million in the course of the year in growth in sales and development income associated with proprietary products. Is there any change in that? I know the numbers are the same. Is there any message or change you’re trying to convey with that at this point?

Don Morel

No, it’s actually comprised of a combination of paid development agreements, private (inaudible) plus revenues from proprietary products.

Arnie Ursaner – CJS Securities

Okay. Thank you very much.

Don Morel

Thank you.

Operator

Thank you. The next question comes from Rafael Tejada of Bank of America.

Rafael Tejada – Bank of America Merrill Lynch

Hey, good morning. Thank you for the questions. So just getting back to the backlog question again, I want to make sure I heard you right. You said backlog was up 11% year-over-year so that’s about $416 million, $415 million or so?

Don Morel

Yeah, that number is up from 1st of the year 2013.

Rafael Tejada – Bank of America Merrill Lynch

Alright, gotcha.

Bill Federici

Our year-end number was roughly around $315 million so $351 million now.

Rafael Tejada – Bank of America Merrill Lynch

Okay. And so I thought it was encouraging to hear that you do have more committed orders for more high-value products. I just wanted to get a better sense of how we should think about the burn in terms of when to expect recognition for that backlog, if anything’s changed in terms of how you see that backlog progressing through the quarters.

Bill Federici

Yeah, primarily as you know the backlog will be revenue generally in the next quarter plus some that falls into the succeeding two quarters after that. That has, the curve of that has shortened – because of our shortened lead times customers don’t need to place their orders as much in advance. So you see a lot of that come through in Q2 and Q3.

Rafael Tejada – Bank of America Merrill Lynch

Okay. And also just thinking about the pacing of the year, you’re reaffirming the sales growth but I’m wondering if you can give us a little bit more detail I guess in terms of how you see the sales trajectory changing, pacing through the year. And you’re reaffirming your margin outlook, too, so just given what we saw in Q1 how do we see that moving through the year? Thanks.

Don Morel

We clearly think that we’re going to see stronger performance in Q2. Our visibility beyond that tails into Q3 a little bit, not so much in Q4. What we’re hearing from our customers is that those orders are going to continue to increase throughout the year, especially the ones that we highlighted in our February call when we had inventory builds for the process change in our LeNuvion facility as well as some new product launches.

So we expect steady improvement both on the sales front and the margin front through the end of the year. Certainly it’s a bit unusual compared to our normal years where we’d historically see the front end loaded for the first six months, but this has happened to us in the past. I think it was ’09 or ’10 where we had a soft first half of the year and then it strengthened… Actually it was ’11 – it strengthened through Q4 of ’11 and then things really started to hit robustly.

Rafael Tejada – Bank of America Merrill Lynch

Okay, just a couple more. Any impact from weather this quarter and I was wondering if you could comment just on, I guess on just purchase orders from pharma, spec pharma – any changes in habits from key end customers?

Don Morel

No, I mean the weather issue was a non-issue for us actually, surprisingly. The one plant we were worried about was our upstate pharma plant in Jersey Shore. Everything was in line with expectations there.

On the specialty pharma front the only change that we have really seen has been the one customer that ceased operations in 2013. They were a contract manufacturer and predominantly consumed the high-value FluroTec and West® closures. So those revenues are being picked up by other customers. We’re seeing slight increases in some and we’ve seen the status quo in others but we haven’t seen any single customer stand out.

The only ones that really have a strong delta are the ones that I spoke about previously that had to do the qualification runs because of the process change at our French plant and those that had strong inventory builds in the second half of the year. But we see those orders returning in Q2.

Rafael Tejada – Bank of America Merrill Lynch

Okay. And this is more of a higher-level question, Don, but one of the questions I’m getting is on basically the potential impact of some of the pharma consolidation, asset changes, etc. And basically just thinking about the way in which in the past these sort of transactions have impacted the business, whether as it relates to inventory de-stocking, and so just wanted to get your perspective on what you’re seeing out there – any concern in the business and I guess any actions to mitigate any sort of risks that may present? And a lot of these things are so early but I just wanted to get your thoughts.

Don Morel

Yeah, I think the key point, Rafael, is what you said at the end – they are very early. Once they close and we consolidate some plans the merger plans begin to take effect. The principle effect on us tends to be a delay in development programs where decisions are pushed off until the organization is worked out and the various lines of decision making are established.

The other way that we’re affected is often if there is a concentration in a particular therapeutic category the regulatory authorities may ask them to divest certain product lines. We usually see those picked up. So there can be a change in order patterns while those sales take place and the new producer picks up the product, but they tend to take place over time and they’re very, very hard to predict.

So qualitatively one, the ways of the development programs and the decisions made there in terms of what to fund and what to prioritize; and two, the product shifts that sometimes take place.

Rafael Tejada – Bank of America Merrill Lynch

Okay, very helpful. Thank you.

Don Morel

Thanks, Rafael.

Operator

Thank you for your question. (Operator instructions.) Your next question comes from Ross Taylor of CL King.

Ross Taylor – CL King and Associates

I just had two or three quick questions. Just first a minor question on the backlog. For last year’s March quarter can you give a percentage breakdown for the high-value products versus the more standard products, just given (inaudible)?

Bill Federici

It was 53% high-value products of the total which is what it is at the end of March this year as well. At the end of December as I mentioned it was down to 49% of total.

Ross Taylor – CL King and Associates

Okay.

Don Morel

Ross, one comment. You have to be careful with that comparison because I would suspect the 2013 number incorporated some volume for the contract manufacturer I spoke about. So the delta is actually better on a comparative basis.

Bill Federici

And we also had longer lead times in March of 2013 so if you’re trying to do apples to apples those lead times have come down. So the customers don’t need to place orders as much in front of when they want delivery as they had back in March of 2013.

Ross Taylor – CL King and Associates

Okay, alright, that’s helpful. And then I’m kind of guessing that that increase in the percentage of the backlog related to the high-value products is one item that gives you a lot of confidence in that forecast you gave out of 8% to 12% growth in the high-value products over the balance of this year. Is that assumption correct?

Don Morel

I think I would put it more into a family as opposed to a single product, Ross. Clearly a lot of that is FluroTec and Teflon-coated closures as well as prefilled syringe plungers. Those would be the driving categories.

Bill Federici

But you’re right – the fact that there is a backlog increase in that composition of the increase is largely related to high-value products. This does give us a lot of comfort that that 8% to 12% growth for the remainder of the year makes a lot of sense to us in high-value products.

Ross Taylor – CL King and Associates

Okay, that’s helpful. And then my last question relates to one of the comments in your press release on SmartDose where you stated that you expect some promising early-stage work to emerge as full-scale development programs during 2014. And if something becomes a full-scale development program does that mean it’s highly likely or 100% likely that it’s going to go into clinical trials? Or how should we think about a “full-scale development program?”

Don Morel

The full-scale development to us means where we are delivering a solution to the customer for either their human use trials and/or clinical trials. When it gets to the utilization phase it usually means that we are at the start of Phase III and we have to have the lines and then we’ll produce actual devices should the regulatory bodies approve the product that will be used when the product goes to market. So full-scale development applies to us delivering those devices for the human use and early clinical trials.

Ross Taylor – CL King and Associates

Okay. That’s great, thanks very much.

Don Morel

Thanks, Ross.

Operator

Thank you. And our next question comes from Arnie Ursaner of CJS Securities.

Arnie Ursaner – CJS Securities

Hi, a couple of quick follow-ups. Normally your Q1 is your peak gross margin quarter as you get the benefit from price increases. Obviously this year’s gross margin was somewhat less. Again, I just want to clarify – there’s nothing other than timing and mix that would affect your gross margin outlook?

Bill Federici

Yeah, the price you mentioned it on, in Packaging Systems the price increase was 0.4 percentage points. If you compare that to Q1 2013 it was 2.4 percentage points.

Arnie Ursaner – CJS Securities

Okay.

Don Morel

Yeah, if you were to normalize the quarter, Arnie, for the HVP sales that declined I think you’d see the margins pretty much in line with where we were in prior-

Arnie Ursaner – CJS Securities

And that plus the pricing.

Bill Federici

And remember, Arnie, as we said in the release normal inflationary cost increases have affected our margin as well. And those things along with when you have less high-value products you have less throughput in the plants so your efficiency isn’t as good, your absorption isn’t as good. So all of those factors together caused that margin to decline by 2.2% on a consolidated basis.

Arnie Ursaner – CJS Securities

And we break out your SG&A in more detail than you do. Just to freshen that up can you comment on your IT spend and your outlook for that for the year?

Bill Federici

The IT spend was down, not a lot – it was roughly the same as it was in Q1 last year. And our spend for the full year will be roughly equivalent to what it was last year.

Arnie Ursaner – CJS Securities

Okay. And I have a more structural question for Don if you don’t mind. There’s been tremendous discussion among healthcare analysts about reimbursement and pricing on orphan drugs. I think the thing that really highlighted this was Gilead and I will mangle the pronunciation of the drug Solvadi. And the conclusion some investors seemed to reach is that healthcare companies were going to stop development of future drugs which would obviously have an enormous impact on you. Care to comment on that, Don?

Don Morel

We certainly haven’t seen any signs of that. I mean obviously the total course of therapy for the Hep-C drug out of Gilead kind of hit everybody between the eyes. I mean there’s no doubt that it’s expensive. But in terms of development programs we see coming in and customer inquiries on closure systems and devices for new drugs we see no change. I mean clearly the conversation is going to continue because of the ACA and reimbursement but if you’re the person that needs the drug I think you’re going to find a way to pay for it.

So we’re optimistic. The pipeline is as good as it’s ever been. The composition of the trials coming through the FDA has a very high percentage of biologics as you know and that’s a space where West really enjoys a comfortable technology advantage currently as well as relationships with those customers that are key. So I’m optimistic.

Arnie Ursaner – CJS Securities

Thank you very much.

Don Morel

Thanks, Arnie.

Operator

I would now like to turn the call over to Mr. Don Morel, Chairman and CEO for closing remarks.

Don Morel

Thank you very much, Operator, and thank you everyone for your time this morning. We look forward to speaking with you again with our Q2 results in the latter part of July or early August. Thank you.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect, have a good day.

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