West Pharmaceutical Services Inc (WST) — Q2 2015 Transcript

Thank you, operator. Good morning, everyone. And welcome to West's second quarter 2015 results conference call. We issued our financial results this morning and the release has been posted in the Investor 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 under Investors on the Presentation Materials tab 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 that presentation 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 U.S. 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's 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 that 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 Eric Green, West's Chief Executive Officer. Eric?

Thank you, John and good morning everyone. Welcome to West's second quarter 2015 earnings call. I'm joined on the call this morning by Bill Federici, our Chief Financial Officer; and Mike Anderson, our Treasurer and Primary Investor Relations Contact. Today, I will review our second quarter results, full year outlook and share my reflections about the business after three months with West. Bill will then provide a deeper review into the financial performance and full year guidance, then we will open up the call for your questions. Starting with the results on Slide 3. We had a strong second quarter with reported revenues of $359.7 million, excluding a 9.9% currency headwind, sales increased 7.4% driven by demand for high value packaging components and proprietary delivery systems. Adjusted EPS of $0.47 includes $0.09 at adverse currency versus last year and would have grown by nearly 8% over the second quarter of prior year on a constant currency basis. As a reminder, the second quarter of 2014 EPS set a record for West. Turning to business segment highlights for the quarter on Slide 4. Revenue in the Pharmaceutical Packaging Systems segment grew 8.5% on a constant currency basis, with double-digit growth in Europe, Asia-Pacific and South America. We continue to experience strong customer demand for the high value packaging components with sales growth of over 12% led by our newer Envision and NovaPure product lines. In our pharmaceutical delivery systems business, revenue grew 6% excluding currency and taking into account the disposition of a small tooling business in 2014. The segment was led by 9.3% growth in the proprietary delivery systems portfolio. We are just really excited about the prospects for SmartDose and CZ products, but the majority of the growth in this quarter came from the more mature proprietary products, drug constitution devices and the air safety system. The second quarter and year-to-date results together with our packaging systems backlog of firm orders and improving visibility into the second half adds to our confidence for the remainder of the year. We estimate constant currency sales growth in the range of 7% to 8% and are therefore raising the lower end of our adjusted EPS guidance range for the full year by $0.05 to be between $1.74 and $1.84. Bill will take you through some of the additional details behind these numbers in a few minutes. To update you on the leadership transition, the past 100 days have gone extremely well. As I mentioned in our April call, I was excited to come to West and I can tell you that my experience thus far has exceeded my expectations. I've spent a significant amount of time with Don Morel and our leadership team visiting several West locations, meeting with key customers and partners and engaging with many of you in the investor community. It was time well spent and I was fortunate to have the opportunity to work alongside Don up to his retirement date on July 1st. I want to again acknowledge and thank Don for many contributions he made to West during his long tenure as the CEO. Our current success and future prospects are rooted in the strategies, culture, and goodwill created under his leadership. Looking forward on Slide 5, we are making investments in West's future growth initiatives around high-value products for Biologics and proprietary delivery devices utilizing CZ and SmartDose. To support the increasing demand for ultra-clean particulate-free components in the near term, we added to a high-value product capacity with new dedicated clean room manufacturing in Kingston, North Carolina. We have begun receiving customer approvals for additional high value products from this plant and expect to ship commercial product in the third quarter. In June, we officially broke ground for a new plant in Waterford, Ireland. This investment is designated to service our key customers in the global diabetes market, which will address the increasing demand for these critical components. I would like now to turn the call over to Bill Federici for a more detailed discussion of our financial results. Bill?

Thank you, Eric, and good morning everyone. We issued our second quarter results this morning reporting net income of $27.8 million or $0.38 per diluted share. Our reported results this quarter include a $0.09 per diluted share one-time charge associated with executive retirements. Excluding this charge, our adjusted earnings per diluted share are $0.47 this quarter, $0.05 below the $0.52 per diluted share earned in the second quarter of '14. Our 2015 earnings have been adversely impacted by the continued decline in the value of the euro and most other foreign currencies in relation to the U.S. dollar. The translation of our international results into U.S. dollars for reporting purposes has reduced our reported earnings by approximately $0.09 per share as compared to the prior year second quarter and by $0.18 per share for the year-to-date June comparison. We manage our foreign currency exposures and generally our local operations are naturally hedged. Turning to sales, Slide 6 shows the components of our consolidated sales increased. Excluding exchange effects, our consolidated second quarter sales of $359.7 million increased by 7.4% versus our second quarter 2014 sales. Packaging system sales increased 8.5% versus the same quarter 2014, excluding exchange. Sales price increases accounted for 1.2 percentage points in the sales increase, and the favorable mix of product sold and volume increases contributed the remainder of the increase. Sales of our high-value products rose 12% versus the prior year second quarter. High-value products represented 45.9% of packaging systems Q2 2015 sales versus 44.4% a year ago. We continue to see strong customer demand for our product offerings that meet our customers' high-quality specifications. Delivery system sales increased by 6% versus the prior year quarter ex-currency and excluding the 2014 divestiture of a contract tooling and services business. Sales of our proprietary products were $29 million or 28.3% of the segment's revenue in the quarter versus $27 million or 27.1% in the prior year quarter. The combined Q2 revenues from CZ and SmartDose of $8 million were roughly equal to the combined 2014 Q2 sales. Contract manufacturing sales increased by 4.9% at constant rates, excluding the impact of the tooling divestiture. As provided on Slide 7, our consolidated gross profit margin for Q2 '15 was 32.8% versus the 33% margin we achieved in the second quarter of 2014. Packaging systems second quarter gross margin of 38.1% was three-tenths of a margin point higher than the 37.8% achieved in the second quarter of '14. The increase in gross margin is due to price increases, the favorable mix of sales, and lower raw material costs offset by normal inflationary increases in labor and overhead costs. Delivery systems second quarter gross margin declined by one margin point to 19.3%, primarily due to the 2014 divestiture of the tooling operation and higher labor and increased overhead costs associated with new capabilities supporting both proprietary and contract manufacturing customer programs. As reflected on Slide 8, Q2 2015 consolidated SG&A expense increased by $3.3 million versus the prior year quarter. A favorable exchange effect partially offset increased sales and marketing expenses related to our global sales meeting held in Q2 2015, which was last held in 2013, as well as increases in regulatory personnel, costs of standardized processes, and information service costs in our packaging systems division as compared to Q2 2014. General corporate costs were $3.2 million above the prior year quarter, due to higher incentive compensation costs, a 2014 medical insurance cost reduction, and higher stock-based compensation costs, offset by a decrease in U.S. pension costs. As a percentage of sales, second quarter 2015 SG&A expense was 16.9% versus 15.6% in the second quarter of 2014. Slide 9 shows our key cash flow and balance sheet metrics. Our year-to-date operating cash flow is $2.6 million above what we generated in the first six months of 2014, despite the negative impact of exchange rates and the higher level of pension funding in 2015. The majority of the $10.9 million executive retiring charge will be settled in stock and is not expected to impact our cash flow. Our capital spending was $57 million for the first six months of 2015, approximately the same as at this time in 2014. We expect to spend approximately $145 million to $155 million in capital in 2015. Approximately 60% of our planned capital spending is dedicated to new products and expansion initiatives, including approximately $28 million for the construction of our new Waterford facility. Our balance sheet continues to be strong and we are confident that our business will provide necessary future liquidity. Our cash balance at June 30th was $252 million, $3.3 million less than our December '14 balance. Foreign exchange reduced our June 2015 overseas cash balances by approximately $13 million. Debt at June 30th was $326.7 million, $10 million less than at year-end. Our net debt to total invested capital ratio at quarter-end was 7%. Working capital totaled $366 million at June 30, $40 million lower than at year-end. The majority of the decrease is due to the reclassification to current liabilities of our Series B euro notes, which mature in February of '16. Looking ahead, our backlog of committed packaging systems order stands at $350 million at June 2015, 8% higher than at year-end excluding exchange. At June 2015, the percentage of high value products in the total backlog is approximately the same as in the 2014 June backlog. Based on our year-to-date 2015 results, our analysis of the orders on hand, and the continuing unfavorable currency effects, we have increased the lower end of our full year 2015 earnings guidance in this morning's release. That guidance is summarized on Slide 10. We've based our guidance on an exchange rate of $1.10 per euro versus the $1.08 per euro rate used in our prior guidance. As a reminder, each one penny strengthening of the dollar versus the euro results in approximately a $0.01 decrease in full year forecasted EPS as a result of translation. Going forward, we expect a $0.05 to $0.06 currency translation headwind in Q3 and another $0.03 to $0.04 headwind in Q4. In addition, our 2015 guidance excludes any impact from a devaluation of the Venezuela bolivar, as we continue to operate primarily under the official exchange rate and excludes the charge associated with our executives' retirement and related costs. I’d now like to turn the call back over to Eric Green. Eric?

Thank you, Bill. In summary, our 7,000 colleagues around the world delivered a solid quarter and a strong first half of 2015. After my first 100 days, I am more firmly convinced that West is well-positioned to benefit from the positive market trends with increased demand for our high value packaging components and proprietary delivery systems. In addition, we are investing appropriately to meet the future needs of our customers and deliver increased shareholder value. Thank you. We now look forward to answering your questions. Operator?

Looking if you guys could just on the strong higher value sales. I realize it's one quarter that doesn’t necessarily make a trend, and I know some of the newer products are coming off of much smaller basis, but I guess nice to see Envision and NovaPure sort of carrying some of the growth load this quarter. Have you any color on that?

Yes, we are very pleased with the results of our high value products portfolio. It continues to gain traction and acceptance in the market as more of our customers require the higher quality of the components with our end products. So we are seeing the demand continues to play well with how West is positioned and also how our operations are being optimized to support these customers in all geographies.

Do you have any updates on the CZ vials? I know you've mentioned the recent approvals of two products. Is the development pipeline expanding? Any thoughts on that?

Yes, Larry, the pipeline of our CZ program still remains very robust. Right now we have 13 CZ programs in formal stability studies and the outlook continues to be positive.

And just back to on the gross margin, in light of some improved visibility and it sounds like packaging systems is doing well. Thoughts on you have your targeted gross margin for the year sort of implies a bit of a contraction in the back half of the year. Is that due to maybe a little slowdown or timing related on some of the higher value products or any other reason for that?

Yes, Larry, basically it's seasonality as historically that's been the case. We have summer shutdowns for preventive maintenance for both our factories in Europe as well as customers' and the startup after that we generally see the second half margins being slightly less than the first half. For the full year, I just want to remind you that we are guiding up for margins both at the gross line and the operating profit line.

And then just last, on SG&A, pretty decent rise if you take out the currency, it is about 12%. I know you cited the global timing of the sales meeting I guess this year versus last year, is that, if you take that out would SG&A look somewhat better or good?

Yes, there is a number of things and you hit on the one that the timing in our global sales meeting which didn’t happen and though it came at all, and then there is also in the second quarter of 2014, we actually had a slight reduction in our medical costs premiums due to some experience adjustments made by the carrier. So we actually got a benefit in the '14 second quarter that’s not present this year. And also, on incentive compensation, we’re tracking a little ahead of our goal so we are taking those comp adjustments that positions up. So those are the three big ones. We’re also adding some heads where we believe it makes a lot of sense in the regulatory space, our customers as the regulators and customers continue to drive towards cleaner products, we have the need for more and more regulatory expertise which is a key differentiator for West in the marketplace. So we will continue to invest in those types of expenses.

Could you talk a little bit about capacity utilization and sort of how should we think about CapEx going into 2016?

Okay. So capacity utilization is a complicated story, but let me try to simplify. On the PPS side in the business, we try to aim for an 85% or so utilization of our plans. However, that’s not a perfect science and certain aspects of the capacity, especially in the high-value products, especially around Envision and especially around washing for Westar, we are very tightly at capacity. We are pushing up against the 100% and that’s why you see our lead times expanding. As we've talked about, we’re continuing to invest prudently in additional water capacity for Westar as well as vision systems for Envision and we’ll continue to invest as well as clean rooms for high-value products. But those are the key investments we’re making which we hope, in the long-term along with our network optimization programs, that we’re working on for the plans, we’ll help alleviate some of that strain in the plans. On the PDS side, it’s more on the contract manufacturing specifically. The utilization percentage is not nearly as high, they are in the kind of high-60s, low-70s and that’s appropriate for that kind of business and we feel very comfortable with that right now.

I think we've been surprised to just see how strong the packaging systems business has remained going forward and I would look at it otherwise down two quarters. So I guess when you sort of look at that, is this sort of growth level that you're seeing sustainable in the next year? And then sort of talking about it on the delivery system side, are you expecting to see that business accelerate?

Yes, Derek, it's a really good point. The packaging systems business, we continue to see the outlook of the high-value products to continue to be very robust. We believe we can continue to perform at similar levels that we have been performing and that's the reason I will add to continue to add capacities within the three main geographies of Asia, Europe and in the U.S. Your point is valid, and there are delivery devices business where we're looking at future investments that pay back over the longer term and we're very optimistic with when we are sort of looking at the level of engagement we have with the customers and the active programs with SmartDose. I mentioned when it was in phase III and then also with the 13 programs with formal stability with the CD product portfolio. So you are going to see it for the longer term what the delivery systems business unit around.

I mean, I’ve been watching the stock and filling up for a number of years and certainly see the, always seems to be on the comp. I mean, are you less enthusiastic about seeing the avenue we were in the past? I'm just curious in terms of your thought on that in that business?

Let me start by saying that the outlook for our store remains very strong and there is a timeline for adoption by customers, but what we're seeing with our clients is that the attributes allow them to be more effective in the end markets. So we believe that we have the right formula. The customers' uptake is visible, there is more in the formal stability trials at this point, so we're pretty optimistic about that, and we'll continue to see demand in the CZ portfolio.

And could you talk a little bit just about sort of your longer term vision in terms of international expansion and sort of market shares internationally and what sort of opportunity to add growth?

Yes, Derek, as you know this is an area that we focused on in the past quite a bit. I believe West is well-positioned to take advantage of the market opportunities in some of the more in Asia and also in Latin America. I think our position today, while we do have presence with the multinationals in China and India and other geographies in Asia, we do have the opportunity to see more expansion. Now we have had, we put investments in China, India, Singapore, but I believe our opportunity to grow faster is present ourselves very nicely for West. So that is an area that we will continue to focus on and put a little more energy and resources around that as we go forward.

Can you just remind me in terms of the geographic split of the business? I’m blanking?

It’s rough numbers in Asia took a little under 10%.

Yes, okay.

It’s about $120 million of sales in Asia.

And who are your major agent competitors?

Well, it depends obviously if you are talking about in China there are a number of companies that manufacture elastomers for drug products. If you are talking about the local markets, there is a wide number, a large number. There are people that work with the multinationals where we are primary. We have market shares that are similar to our western markets for the multinational, so in that kind of 60% to 70% range. In India, it is a mixed bag as well, but again we have very solid market shares with the multinationals in India as well.

And so I guess, on your expansion plans is it necessary to come in the market with a lower priced option?

I believe there is a great opportunity to bring the West quality to the market where it’s not as prevalent. If you look at the cost of our product in the entire end drug delivery, it is a small percentage. Therefore, to increase the level of quality and the acceptance of the drugs into other local markets or global markets, there is a need to pull more West quality into that system.

Thank you, operator. And thank you everyone for your time this morning. We look forward to speaking with you again on our third quarter call in October. Thank you very much.