Good day, ladies and gentlemen, and welcome to the Q2 2017 West Pharmaceutical Services Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to Quintin Lai, Vice President of Investor Relations. You may begin.

Thank you, Leanne. Good morning, and welcome to West's Second Quarter 2017 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. This morning, CEO, Eric Green, and CFO, Bill Federici, will review our results, give you an update on our business and provide an updated financial outlook for the full year 2017. There is a slide presentation that accompanies today's conference call, and a copy of that presentation is also available on the Investor Section of our website. On slide two is the safe harbor statement. Statements made by management on this call and in the presentation contain forward-looking statements within the meaning of U.S. federal securities law. These statements are based on management's beliefs and assumptions, current expectations, estimates and forecasts. There are many factors that can influence the company's future results that are beyond the ability of the company to control or predict. Because of these known or unknown risks or uncertainties, actual results could differ materially from past results and those expressed or implied in any forward-looking statement. For a nonexclusive list of factors which could cause actual results to differ from our expectations, please refer to today's press release as well as any further disclosures the company makes regarding the risks to which it is subject in the company's 10-K, 10-Q, and 8-K reports. In addition, during today's call, management will make reference to non-GAAP financial measures, including: sales in constant currency, organic sales, adjusted operating profit, adjusted operating profit margin 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 this morning's earnings release. I now turn the call over to West's CEO and President, Eric Green.

Thank you, Quentin, and good morning, everyone. Following a strong start to the year, our second quarter performance fell short of expectations. While we delivered 4% organic sales growth, with strong performance in Contract Manufacturing and Pharma, unexpected softness in Generics and Biologics caused an unfavorable sales mix, which resulted in a drop in the gross margin for the quarter. While we have taken several actions, including increased customer interactions, to better forecast their demand patterns and have put in place increased cost controls over our processes, we remain confident that the fundamentals of our markets, our products, and our strategy are solid. Our long-term outlook remains unchanged and we believe that our growth profile will improve in Q4 of this year. I will focus my comments on the details of our sales performance in the quarter. First, at a high level, two areas of our business, Contract Manufacturing and the Pharma market unit, which account for approximately 55% of our total sales, performed well and were at or above our expectations. On the other hand, the Generics and Biologics market units, approximately 45% of our total sales and accounting for 70% of total high-value product sales, were softer than expected due to a variety of customer issues, included continued customer inventory management, drug-launch delays, and customer-related regulatory issues. I will go into more detail in a moment. Turning to slide four. We have laid out our organic sales performance over the last 5 quarters and show our updated full year guidance for each market unit and the Contract Manufacturing segment. I want to take some time to go through each of the businesses in detail regarding the second quarter and talk about the outlook for the balance of 2017. As we expected, Pharma grew mid-single digits after strong double-digit…

Thank you, Eric, and good morning, everyone. We issued our second quarter results this morning, reporting net income of $38.8 million or $0.51 per diluted share. Our reported results this quarter include a $0.15 per share charge for the deconsolidation of our operations in Venezuela. Excluding this charge, our Q2 2017 adjusted diluted EPS was $0.66 as compared to adjusted diluted earnings of $0.59 in Q2 of 2016. As a reminder, 2017 reported earnings include tax benefits on option exercises due to an accounting change that took effect in 2017. Our Q2 2017 reported earnings includes a $0.13 per diluted share tax benefit related to stock option exercises. A reconciliation of non-GAAP measures is included at slides 12 through 15 in the presentation that accompanies this call. Turning to sales. slide seven shows the components of our consolidated sales increase. Our consolidated second quarter sales of $397.6 million increased by 2.5% versus our second quarter 2016 sales. Excluding the $5.6 million adverse currency effect, our Q2 2017 sales increased 3.9%. Proprietary net sales increased 2.2% versus the same quarter in 2016 excluding exchange. Sales price increases were marginal. Higher sales of CZ and SmartDose, as well as gains in tooling and development revenues, contributed the majority of these sales increases. Sales of our high-value products rose just 2.2% versus the prior year second quarter. Current quarter HVP sales as a percentage of total proprietary products sales were unchanged versus a year ago. Both Q2 2016 and the first half of 2016 saw significant growth in HVPs, up 16.6% and 19.6% respectively. The combined Q2 revenues from CZ and SmartDose of approximately $10 million were $6 million more than the combined 2016 Q2 sales, reflecting strong customer demand. Contract manufactured net sales increased by 10.5% versus the prior year quarter, driven…

Thank you, Bill. In closing, we remain confident that the fundamentals of our markets, our products and our strategy are solid. We are maintaining our leadership position with customers. We are expanding our customer portfolio with emerging Biotech and small pharmas as the number of new therapies based on injectable drugs continues to grow. The regulatory hurdles for quality and reliability continue to rise, and our global customer base is increasingly looking to West for worldwide availability, scientific expertise, innovative new components and injection devices, and deep technical service, which we continue to deliver. I want to be clear, we see no change in the fundamental growth drivers and no change in long-term sales growth expectations of 6% to 8% per annum with approximately 100 basis points of operating profit margin expansion per year. Leanne, we're ready to take questions. Thank you.

[Operator Instructions] And your first question comes from Tim Evans with Wells Fargo.

This is Sara on for Tim. I have a question on cost. I was wondering what levers can you guys pull to manage costs during the delays. I think you mentioned earlier on the call you're implementing some cost controls. And then, kind of, as a related question, how should we be thinking about operating margin expansion this year given the headwinds?

So when we were looking at our opportunities, what levers we have available to our business on a short term. It's more around typical cost measures around how we are deploying our resources in our plants. It's also looking at ways to reduce our SG&A or maintain our SG&A as a percentage of sales around that 15% to 15.5%, which we're currently at. This is more around the discretionary spend that we have here at West. Fundamentally, we look at our infrastructure and you look at where we have our operations and our plants and the capacity we have available. There is a demand. We expected demand to continue to pick up latter part of this year. We are ready to take that on. So that's -- the lever we're looking at is more around the discretionary.

And just to answer your question directly on the operating profit margin expansion. We do expect about a 100 basis points increase based on our current forecast versus prior year.

And then in terms of visibility, what are you guys doing to gain better visibility with your clients? I don't know how much you can share with us but are you able to provide, kind of, any narrative of what changed between now and last quarter and what you're, kind of, doing to address that?

Yes, so what we're doing with our global operations team in our commercial organization is that we have a very robust supply chain group that is actually being tied to our customers and started looking at demand patterns. Not just historic but also forward looking. And so these are the initiatives that we have put in place. But it is really around the overall demand planning, not insular but actually working side-by-side with our customers. Just to reiterate, I mentioned earlier that I had a meeting -- several of us had a meeting with the key leaders of a major Pharma company up in Jersey Shore, and that was one of the key deliverables from that discussion is integrating our group with their group to actually build forecast and demand short-term and more long-term.

Your next question is from William March with Janney. Please go ahead.

So first question, Bill, just if you could provide a little more color around the second half financials. Just in terms of 3Q is typically a lighter quarter as factories are retooling, so maybe just a little bit on the revenue cadence. And then you also highlighted a 100 basis points of margin expansion. Is that mainly going to be coming in 4Q, at what -- considering the flat EPS? So just a little more color on the model.

So, yes, I think what we've said in the release and what we're confirming here is that Q3 will be flat on the EPS line to prior-year. We will continue to see the effects of the Generics and the Bio being soft. As we look towards the fourth quarter, we will be expecting to see more -- a return to a more normal order pattern from our customers in both of those regards. So less robust in Q3 as we expect normally in sales but higher growth rates in the fourth quarter.

And then, Eric, maybe just you highlighted the double-digit growth in CZ and SmartDose and called out a couple of new customer wins. Could you just give us a sense of the growth you're seeing? Is that coming from the products that have recently been approved commercially, or are you seeing stronger growth from clinical trial and stability trial work?

Yes, so around CZ and SmartDose what you're seeing, the increase, as we anticipated this year, is really due to commercial launches. And what we're -- in our comment about additional DAs in the areas around SmartDose it's obviously filling the pipeline for future opportunities. But the growth you're seeing today is really around the commercial launches.

Your next question is from Larry Solow with CJS Securities. Your line is open.

I was wondering if you can give a little more color, your proprietary orders, down 7%. I realize obviously, this is a function of several positive variables, including reduced lead times and your improved throughput and capacity expansion. But is there any way to sort of -- is this year-over-year decline of 7%, is that also being impacted, I assume, by some slowdown in the -- outside of the inventory management, but some of the slowdowns you guys have cited?

Yes, let me -- so no, Larry, that's a very good question and thank you for bringing that up. I think when you take a look at our high-value products in our backlog today, I'm really pleased with the progress of our operations teams have delivered on over the last 12 to 18 months. Just to remind you, if we look at our high-value product portfolio, it's roughly around 17% -- last year it was about 17% of the number of units we produced at West. And when you break it down, one of the early entrants of highlighted products for us historically has been around Westar. And that process is roughly 1/3 of the high-value product portfolio. Just to remind you that about two years ago with customers, we were averaging a little over 30 weeks for lead times. And that's not acceptable. The work that has been in place today, we're less than a third of that to our customers from a lead time perspective. And that work over the last year, year and a half, is a direct correlation or a direct impact on the increased confidence from our customers and reducing the large bolus orders that were coming in, historically, due to the lead times. I also just -- just to build off of that, to give you a line of sight and confidence. While the Westar is down, was down double digits in the last quarter, the other parts of the high-value product portfolio that we're pushing into new commercial drugs and opportunities, is growing very strongly. Such as, you talked about the self-injection CZ already with your initial question. But the NovaPure and the Envision line, all very much strong double-digit. Yes, from a smaller base, but this supports the strategy of continuously expanding the pipeline of new products, higher quality, to meet the needs of our customers. So it really is that the backlog right now is a direct correlation to the reduction in lead times, specifically around the Westar processing in the Generics space.

And then just -- if we can just shift back a little bit on the -- you discussed obviously the slowdown in the quarter on both Biologics and Generics. And just to focus on the Biologics side, is the inventory management -- it sounds like that sort of also ties into some of the delayed ramps that these customers are -- is that change in their plans on their own side? Or is that more of a regulatory -- delayed approvals and whatnot that's causing some of this?

Yes, Larry, mostly in the Biologics space is -- a lot of that's driven from our customers in new commercial launches. There is a -- There was some due to a similar situation with Generics but that's at a much lesser extent. It's really around delayed drug products into the marketplace that we have visibility of, and I won't go into details of any one particular customer. But we believe, based on the conversations that latter part of this year, we'll see those becoming real in far as commercial revenue for West to our customers.

So that sounds like it's more customer decisions timing related. It's not as if there's been -- that they were too aggressive on their approval forecast or as a whole forecasts were too aggressive or anything.

No, Larry, as you know -- a lot of -- many of our customers when they're about to launch new molecules, they buy in -- buy ahead and to prepare for the launch. And if there's a delay in the launch, it does create a little bit of an issue on the flow of new orders. I just want to reiterate, when you look at Biologics, we have no visibility of any lost sales. And the questions that I look at every day is, when you look at new molecules coming through the pipeline, are we participating on those molecules? And we can confidently say yes, specifically in the Biologics space, it's very positive. Now I'll just give you an example, there's a major customer with a major biosimilar that's just been recommended for approval in the bio presentation, and what I'm excited about is that our NovaPure line is on that. So again, it's another win for West but frankly speaking, it's a win for our customers and for the ultimate patient.

And then just on the Generics side, that sounds like that's a little bit more, at least recently, a little bit more regulatory issues that sort of crimped production. And you guys, fairly enough, sounds like you don't have great visibilty on that at least for the next couple of quarters. So you go down in Q3 and, I guess you have some visibility on the timing of other orders so that that'll improve, that'll offset some of the weakness. Any way to sort of gauge maybe very high level, what some of these regulatory issues are or would that potentially crimp -- has there been a change in standards or anything or is it or anything like that? Or is it more just coincidental timing that where a bunch of the regulatory issues sort of bunched together, to cause a more significant slowdown that was noticeable for you guys?

Yes, Larry, it's a good question. Let me try to dimension this for you. When we're looking at the business of Generics today, in the asked question, there's been a decline. So we said mid-single-digit decline in Q3. Last quarter, we were sitting here saying that we felt more comfortable of the large Generic players, which is was about 4 of them, frankly, make up 40% of the Generics business. We have visibility line of sight, orders on hand and how that's going to play out for the rest of the year. What we didn't anticipate, frankly, is about half of the decline of that mid-single-digit decline in Generics came from mostly in India. What we've seen there is that it's not just one or two, there's several of our customers that have gone through audits and they have 40 trees that were supplied. And that has delays right now on material going into those customers to produce. Now, we're very sensitive to the fact that if they're not able to correct their -- they have corrective actions that actually get approved, we know that these drugs will have to be picked up from somewhere else. And we're staying tuned to that. Our best estimate based on talking to the customers and also looking at some available data in the marketplace such as IMS, suggests between three to six plus months before a transition would occur. Now that's what we're focused on right now. So about half of the decline in Generics came from specifically, not a 100% but mostly out of our customers in India.

And that's where the regulatory issues have obviously appeared then?

Correct.

And then just last question, just on the euro. The, I guess, the -- using an average of $1.14 versus a prior $1.05. I guess that's $0.09. Is that about just the historical $0.01 to $0.01 rate still apply?

Yes, Larry, it's a little bit less than that because you got some other currencies running against you in Asia and Europe -- Asia and South America. The way we're looking at is that is about $0.03 in the back half of the year will be the benefit. If it stays at $1.14 for the for the rest of the year.

Instead of the 4.5 you get a little offset on the Asian currencies so it's about $0.03. So that's great. I appreciate that..

Your next question is from Dave Windley with Jefferies. Your line is open.

This is Jared Meggison on for Dave, this morning. I have one quick question. Regarding high-value products, so we've had a little bit slower growth in 1Q and 2Q, now. And I'm just wondering, how are you guys doing the switch up the value chain for high-value products? Is there still demand from customers to move from Westar and FluroTec all the way up to NovaPure? Or given kind of the slower environment here, is there may be a slowdown in that shift up the chain?

Yes, that's a very good question, thank you. When you look at the high-value product portfolio and you look at the whole spectrum that we've laid out on the bottom left hand side of that portfolio, it's really the Westar, an entry point of high-value products. And that's where we've seen the decline, specifically around the customers that I mentioned around the Generic space. When you look around the NovaPure and Envision, they're all -- again, it's a small base. If you look at Westar, it is larger than the accumulation of self-injection CZ administration systems for NovaPure and Envision. But those product portfolios are growing well in the double digits, significantly. So we're seeing a continued migration towards the highest Quality by Design of NovaPure. We're also seeing an increase in Envision's inspection requirements, specifically in the Biologics and now coming into the Generics space. So we're comfortable that we're continuously moving up the value chain when you look at the quality of these new products. I just want to reiterate though the high-value products right now -- or last year, was about 17% of the number of units we produced. And we believe that will continuously increase 100 basis points to 150 basis points every year.

Your next question is from Derik De Bruin with Bank of America Merrill Lynch.

I'm pleasantly surprised to hear that you're still talking about a 100 basis points of margin expansion this year, that's certainly better than we had on our first pass at the model. Could you just sort of talk about how much of that is sort of like currency rate versus operational, just like that, could you just sort of walk it, what's on the underlying op margin for guide?

Yes, so currency is not going to affect the margin percentage very much. It does affect -- its $0.03 on the EPS but the margin is generally not terribly affected by it. We do have, as Eric mentioned, we have operational work that we are working on with our group in the operations. That should bring down the operating cost a little bit. And we're looking at continued cost controls around SG&A that will help. And then we believe that there's the ramp up in HVPs in the back half of the year that as we -- as I mentioned in my prepared remarks that the HVP growth has a very large impact on that mix shift, has a very large impact on our margins. So we believe that that's the big story there. So returning to, hopefully, normal order patterns in Q4. Good cost controls as well as operational efficiencies,, and we believe we would get to approximately 100% -- 100 basis points.

So this sort of then begs the question -- I'm getting this from a couple of people this morning, it's like, I mean, you've seen -- this isn't the first time we've sort of seen these sort of -- this isn't the first time we've seen some of the slippage in terms of the HVPs and things like that. I think you go back 2011-14, there was another historical event like this. Can you sort of talk about, comparing to what you've seen in the past and how long it took you to reset and the -- how this sort of compares to some of the other delays and some of the other things you've seen in the past?

And yes, absolutely, we have seen this before in the first quarter of '14 and also in 2011 and quite frankly, before that in 2008 and '09 as well. It is -- yes, the underlying fundamentals of the business are that if the products don't go away, if they're not pulled from the marketplace, or if there is no leakage to other -- of market share, that we will continue to see those units when it's comes back. And a lot of what we're seeing today is driven by both the -- our operational excellence, where we've reduced lead times and also customer inventory management issues. So some of this is expected to happen. It does happen periodically, and we do believe that we will continue to grow. The marketplace's -- the marketplace demand for our higher value products driven by the need for a higher quality product, more purity and more -- cleaner product, what our customers call zero-defect mentality, is going to continue to drive the need for high-value products. And as we continue to believe, we've got very high market share in the Biologic space. We're not losing any business in -- been no fundamental change. So we believe that these order patterns will return more to normal. And then lastly, I think there's also, you've got to remember, we grew very, very high percentages of high-value products I mentioned both in the first half, in the first quarter -- the first two quarters of 2016 in high-value products. The growth rates were high-teens. So those are above the norm of where we would say high-value products should go, which is high singles to low doubles. So there is a return to, a reversion to more of the mean. And that's what we're seeing today. No lost business. No change in the fundamentals. We believe that the products are still there. The demand is there. It's just got to -- it'll come back in future quarters.

And that was, sort of, the question on basically nothing to shake your long term outlook?

Absolutely nothing.

No, Dave no change.

So I guess on the Generic issue and sort of like the 43 and the quality issues there. It's like you solved some -- you had some issues with the Generics customers in Q4 and in Q1. Were these sort of like -- the ones that sort of manifested this quarter, were these the same ones or were these new ones? Just like I'm sort of thinking about your visibility in terms of what is it. Is it like stuff that lingered or it's sort of like whack-a-mole where new ones are popping up?

Yes, from our perspective, working with our customers, there's newer issues that are being faced with our customers, specifically in India. While there are some issues that are outside India. They've been going on for some time now. This is specifically, more than a handful, I would say, in India.

And just the -- you talked about FX being a tailwind for that. What's the overall topline tailwind? What's the overall topline for the full year for the FX contribution?

Well, I'll just tell you, in the back half of the year, it'll be approximately $20 million.

Can we talk a little bit about the tax rate as well?

Sure.

Just a sense as you get the stock option changes, I realize that makes things a little bit lumpy. But how do we -- any guidance in terms of how to think about it, given it's been in single digits the last two quarters?

Yes, and that's driven by this -- by the tax benefit from those option exercises. If you pull that out, the business is still strong in -- from a geographic mix perspective in the U.S. and in places like Germany, which have high tax rates. So if you strip that out, our tax rate, if you're thinking about tax rate without it, should be about 30.5%.

But, yes, yes, but yes okay. It sort of makes the next couple of quarters -- it just makes quarters much more complicated to model.

It does, and we apologize for the accounting change but there's not much we can do about it.

No, you are not the only ones who are doing this. It's just it's always a surprise now whenever we read it, the earnings releases.

And I'm showing no further questions. I would like to turn the call back over to Quintin Lai for any further remarks.

Thanks, Leanne. Thank you for joining us on today's conference call. An online archive of the broadcast will be available on our website at www.westpharma.com in the Investors section. Additionally, you can get a telephone replay through Thursday, August 3rd, by dialing the numbers and conference ID provided at the end of today's earnings release. That concludes this call. Have a nice day.

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program and you may all disconnect. Everyone have a great day.