West Pharmaceutical Services, Inc. (WST) Earnings Call Transcript & Summary

Hi, everyone. Welcome to the 2021 JPMorgan Healthcare Conference. My name is Casey Woodring. I'm a member of the life science tools and diagnostics equity research team here at JPMorgan. Today, it is my pleasure to introduce the management team from West Pharmaceutical Services. As a reminder, if you would like to ask a question, please feel free to submit via the presentation web page. And with that, let me turn it over to Eric.

Great. Casey, thank you. Thank you for the introduction, and thank you to JPMorgan for hosting us at this year's conference. And we hope that next year, sure, all would agree that we would like to be able to see everyone in person in San Francisco. Today, I have a few slides like to share with you and walk through and -- on the exciting work being done here at West. And then our CFO, Bernard Birkett, will join me in the Q&A session following the representation. On Slide 2, before we get started, I do want to highlight the safe harbor statement, which can be found in the slide presentation materials that have been distributed and/or you can receive the information from our website at westpharma.com. So let's get started on Slide 3. For those who aren't as familiar with the company, West is a global leader in containment and delivery of injectable medicines. And in the century-long history of West, our criticality of our purpose could be any more clear during times like today, not only delivering on our core business but also playing our role in the fight against the pandemic. Our mission and our vision in this space is consistently led by our 3 core values as passion for customers, leadership and quality and a One West philosophy of teamwork and collaboration. Turning to Slide 4. We have a resilient business, and we're operating from a platform of strength. When you look at the diversity of the geography, we match our global customers, over 50% of our revenues are outside of the Americas. From a product lens perspective, high-value product components and high-value product delivery devices make up approximately half of the company's revenues in the first 9 months of 2020. And thinking about the market units that we are focused on as a market-led organization, our largest unit, and a few years ago, I couldn't say this, but as of the first 9 months of 2020, biologics is now the largest market unit at West, and we're excited about the growth trajectory that we have in that particular segment. We have over 10,000 employees driving performance each and every day, and we have a very large manufacturing scale capability with 25 sites and producing over 100 million units a day, and our customer base is diverse, and we're continuously driving innovation to support our customers as is evident when you think about the number of patents that we have filed over the last couple of years. Looking at Slide 5. A few years ago, we realigned the company around a market-led strategy, where we felt that we could respond faster and create more value by addressing the pressing needs of our customers who are working in the highly regulated markets. Let's peel back a bit. On the commercial side, we aligned our organization with biologics. So the large molecules. We looked at the generics, particularly in the small molecule area and then the pharma branded, again, small molecule. We also have a fourth unit as contract manufacturing that we repurposed to be focused around the health care sector and less focus around the consumer products. That engine, that commercial engine that market lens has been driving our performance around product management and R&D. What products we are developing, line extensions and/or new innovations that are brought to market to continuously drive the high-value product portfolio. Particularly, we're seeing great traction in the Crystal Zenith injection devices. And behind all that, we have this -- we've globalized our operations, which is paying dividends today as we've gone from a site region perspective to really truly global operations, allowing us to flex the network more effectively to be able to respond to the demand and needs. If you turn to Slide 6, what's interesting about this, this is the framework of our portfolio and the continuous focus on driving -- which drives top and bottom line growth so let's talk a little bit about the orientation of the slide. The X-axis is increased value to our customers. The Y-axis is increasing value to West, which means both ASPs and margin potential. As quality requirements continue to rise, both by our customers and regulators, we have seen growing demand each year for our HVP processes such as Westar pharma grade wash, Westar RU sterilized components. In the biologics drugs, most of which are large molecule proteins, are extremely sensitive to the packaging which has resulted in tremendous adoption of FluroTec coated components provided by both us and our partner in Japan, Daikyo. And we're also developing our best-in-class quality by design NovaPure, which is the highest level as you kind of go up the continuum, and we're seeing high adoption by recently approved biologic drugs that expect this portfolio into their filings. I can't go without saying that the Crystal Zenith continues to gain traction in those most complex biologic requirements. And also in our self-injection platform, we continue to see increased interest in our SmartDose platform truly draw towards the biologics sector. Moving to Slide 7. The sales performance of the organization over the last 5 years has been robust. We've always talked about a 6% to 8% top line construct from an organic growth perspective. And we have been performing at the higher end of that range. As we turn our attention the first 9 months of 2020, we obviously exceeded that quite considerably, and there's an element of COVID impact, but also the core business continues to gain traction to accelerate closer to the double-digit growth. And that's across both proprietary products and contract manufacturing. What's interesting by turning to Slide 8, is when we look at what is the thesis to driver of West? And is there opportunity to continue on that journey into the number of years ahead of us? Just to orientate you on this slide, on the left-hand side, the number of units produced in our facilities. So when we talk about over 40 billion components at less per year. And roughly within proprietary, if you take contract manufacturing out of the equation, it's roughly around 32 billion components per year. Roughly around 22% of those components for the first 9 months of 2020 has been within our high-value products. What you'll notice is that it's about 100 basis points or a percentage point each year incremental since 2015. And how that translates into the revenue is that it's gone from 53% of our total sales of proprietary, up to 65%. So obviously, the driver of higher ASPs. If you think about the margin profile, our 2 highest growth areas at West, and we have -- we still feel there's a tremendous runway ahead of us is the high-value product components and the delivery devices, where you can see the margins are above the corporate average of 35.5%. And then you have the standard packaging and contract manufacturing, which is less than that. What really aligns well here is the biologics growth of the business, the high participation rate that we have at West with our customers on the number of approvals in the marketplace, having our products, the high-value products, on that continues to drive that momentum going forward. If you bring that all together, on Slide 9, what you've seen is sustainable, consistent growth and aligning the unique value propositions and the business model is really driving revenue growth and margin expansion, which translates into our EPS, and obviously, on the right-hand side, the value that has been created with our shareholders. One thing that I know the team around the world at West is proud of is that end of 2015, we were added to the S&P 400, in 2020, we were added to the S&P 500. So we're very pleased with the progress, but we think there's a lot more to do. And as you transition to Slide 10, it's an exciting landscape that we operate in. If you think about looking forward, it's very attractive, robust markets, the injectable medicines space. The fastest-growing element of that is the biologics area. And as I said earlier, that's the fastest-growing segment for West, but it's our highest participation rate for each and every molecule that's been approved around the globe. There's an increase in linkage between primary containment and delivery devices. And at West, we've been successful bringing that together. When I look at -- looking the future for West, it is around execute, it's around innovate and it's around growth. So the first one around execute is to continue to build the momentum and success of the market-led strategy. It's the second element of execute is further globalization of our operating model. And the third is continue this shift from analog to a digital environment throughout the globe. So turning to Slide 11. This goes in a little greater detail on our market-led approach. Being market-led means working with customer groups that have specific needs. And for example, in the biologics, it's the sensitive drugs, also looking at ways to move from IV to subcu, an environment which aligns really well with our on-body wearables solution, the SmartDose. In generics, higher awareness of quality requirements and deciding to outsource high-value products to us, to West, instead of trying to build in-house capabilities. And now they're looking to even further differentiate those molecules with devices. And in the pharma small molecule branded area, they're mature. There's a focus around total cost of ownership, but we're also seeing tremendous growth opportunity around the e-pharma, and we have created new formulations within high-value products to really help drive these new molecules through approval. So as you think about the market-led approach that we've implemented and it's maturing more throughout the organization, we're very well positioned to continue to drive market-leading growth in all segments that we support. I can't go any further without talking a little bit more about Slide 12. The biggest question that we have received throughout the day on our one on ones or the group sessions and throughout the organization is what is West's participation with COVID. In early 2020, we got some intel through the various government agencies throughout the world, obviously, some of our leadership in Asia Pacific started to give us insights on what's happening in that region and about the emergence of COVID-19. We activated our emergency response team here at West. I couldn't be more proud of how that team has come together globally to really ensure 2 priorities in this company, and it still stands as the top 2 priorities. Number 1 is to ensure the safety of our employees and their families at all times. And secondly is to ensure continuity of supply to our customers during these times of flux, whether it's supply chain challenges, whether it's other headwinds that are unpredictable at times like this. In our values -- when I talked about earlier at 3 core values, they're on full display, frankly. And I couldn't be more proud and humbled by the reaction of our colleagues. To give you one small example is as we've been facing early on was around diagnostics, how can our contract manufacturing business support diagnostics requirements of our customers to detect COVID. Then it transferred into therapeutics, a number of therapeutics what we're participating on have been approved and then has moved into the vaccine conversation. And West, as you can imagine, has been very active in those discussions and has a very high participation rate on these vaccines. And that demand has translated into volume increases into our plants. So we initiated moving our plants to 25 plants to most of them towards a 24/7 concept. We had to onboard a number of new employees to the organization and train them on our processes. We also identified ways to have our customers working on various vaccines, narrow in on a select group of products that we knew could be supportive of multiple vaccines, which tends to be around the FluroTec coated polymer color coated stopper for vial configuration, obviously, seals and also with NovaPure. We have increased our capacity by bringing in additional equipment, not bricks and mortar, but new equipment to actually a modular approach to expand our capacity in those specific areas of FluroTec and NovaPure. And as we communicated earlier, those investments were already earmarked in our 5-year plan. And as we think about going forward, that's now being installed here as we speak and being validated and ready for commercialization. So when we think about our core business and we think about how we leverage the global operations through those changes we made a few years ago, has put us in a position to be able to respond effectively to be able to be a part in a serious solution partner for this pandemic. It's interesting times, but I'm really proud of the team around the globe and how they responded. Going back to the execute on the second lever is really globalization of our business. And we have, as I talked about, the global operations, it's more than that. It's looking at how we can drive more globalization of every function in this organization to align ourselves to our customers, which are expecting those type of results. We have more initiatives to further raise the bar on safety and quality and capacity and COGS utilization. And as I said earlier, digital is an important enabler to drive globalization through all parts of the organization. Turning to Slide 14. As we go to the second major pillar at West is around -- the focus around innovate. If you think about R&D, keeping stride with the changes in science, whether it's the cell or gene therapy drugs and their specialized containment delivery needs all the way to life cycle management of mature drugs. And we have aligned the organization in R&D to enable to respond to both new innovations and also improvement on existing portfolios to be able to respond to our customers. I'm excited about the journey that we're on in R&D and the future launches of new products and solutions and services that will be a result of those efforts. Turning to Slide 15. If you look at our capital deployment, this is about the growth. Now we have historically the last several years, actually, 28 years, consecutive years, increased our dividends here at West. We also have, in the last several years, done a share buyback program to really offset the dilution effect of incentive programs, and we have authorized another 631,000 shares for the next 2021. We've also, from an organic growth perspective, as I just mentioned earlier, increased capital expenditures on specific equipment focused around FluroTec and NovaPure to enable us to respond to the core business growth, but also to the COVID vaccine demand requirements that we have with multiple customers. And as several of the vaccines get approved, we're able to respond appropriately over the next several months or quarters to be able to ensure that we are consistently as we are today, hitting the delivery dates for each and every one of those customers. As we kind of think forward is that what other elements of growth can we use? Our additional free cash flow that we're seeing in this organization has been building up. And we'll continuously look at opportunities that may round out our portfolio or provide additional services or capabilities that our customers are looking forward to have a complete solution with their interaction with West. If I turn to Slide 15. And I apologize, 16, Slide 16. This is kind of encapsulate really an element of how we think about ESG at West. This has been in play for a number of years. The team has done a great job to stay focused. We have goals [indiscernible] for 2023. If you don't know, that's our 100-year anniversary at West. We thought it would be appropriate to set our next set of targets towards that year. And we're seeing great accomplishments across the organization in multiple ways, whether it's around compliance and ethics, philanthropy continues to see improvements with health and safety, diversity and talent in the organization, environmental sustainability and quality. We believe we are the market leader in quality in our space, and we've always believed that there's continuous opportunities to improve that and raise the bar because our customers and regulators are expecting that of us. So to summarize, on Slide 17, when you think about the strategy of West, I'm really excited about the future. We have a phenomenal platform to work from. Today, we have -- we're really critical in the process, not just on the core business, but also to be able to support our customers and support society around combating the COVID-19. Our participation rate remains very high, and our products that are being used in these battles is really run our high-value products and also going all the way to NovaPure. In our globalization, when you think about the operations, if we would not have done what we did over the last few years, we would not be able to respond as we are today. So I'm very proud about the work that we've done, but the team is -- feels that we're just in the early innings. We're driving automation. We have new automated work cells and a few of our sites that we're continuously expanding. We're driving more globalization of our supply chain and movement of goods. We're working with our customers to have multiple sites approved based on our process approach versus a site approach. And when you think about all these changes that are being made, it only allows us to be more responsive, leverage our assets more effectively and be able to really support the growth that's occurring in the industry. When I think about the fueling of innovation and making sure that we're aligning to our customers, I truly believe the market-led strategy is bringing those new ideas back to the table and allow us to assess how can we respond, how do we provide the right product and the right solution to our customers. And the other element that's not listed in here is around digital. We have done tremendous work in the last 2 years to digitize a lot of our processes and connected to our equipment and also created a constant ERP system in our organization that allows us to think and then move quicker and faster with information to be able to respond to the market changing needs on a regular basis. All this with our phenomenal culture at West and also with the dedication of 10,000 employees, we do believe we are creating tremendous value for our customers, ultimately, the patients, our fellow colleagues around the globe and obviously, the shareholders. So on that, I am going to turn it back to Casey and turn this into a Q&A session. So thank you.

Great. Thanks. That was a great overview. Maybe the first question that just came over via e-mail was given the lower expected patient volumes, how much of an opportunity will cell and gene therapy be for you 5 years down the line?

Yes. So we're participating in that area, a very high participation rate, obviously. And if we think about 5-plus years down the road, it depends on type of treatment that will be performed, the volume aspect, and we're looking at ways to put in a service element to that, so there's more value per injection concept. But at this point, I think it's too early to articulate what percentage of our business will be in cell and gene therapy 5 years out.

Got you. Given the increasing percentage of sales represented by biologics and the biologics industry growth of 12% to 15% that's not including biosimilar expansion that's likely in the next couple of years. Why is 6% to 8% the right midterm guide?

Yes. The way I would respond to that is, you're right in the fact that more recent quarters without COVID, we're on the high end of that 6% to 8%, in fact, a little bit over. You throw in what we're doing right now with COVID and the duration of that, does it bring it much higher than that? But when we think long term without COVID, we're very comfortable with the 6% to 8%, long term. That is consistently growing in high-value products in double digits. It's continue -- and also in addition to that, expanding our operating margins at least 100 basis points per year. So that construct, we're very comfortable with. But internally, I can tell you, we're shooting for stronger numbers than just the 6% to 8%.

Got you. So as far as COVID goes, West is playing a role of the supply components to drug and vaccine developers and companies that are addressing the pandemic. You mentioned that you're accelerating manufacturing capacity ahead of potential vaccine approvals. Can you give us an update on that and provide any more color that you can share?

Yes. So midway through last year when we were in discussions with several companies looking to develop vaccines and the decision to go with FluroTec and also, in some cases, NovaPure, we looked at the mapping of our current business plan and the future demand put on these other requirements around the vaccines. We needed to bring forward some of the capital 2 or 3 years out from now to bring forward now. [Technical Difficulty] decision in 2020. We spent some of the money in 2020. Some of the equipment was installed in Q4 through installation and validation now ramping up to for production purposes. And then throughout 2021, we'll have even more equipment installed throughout the year to be able to react to these demand requirements. So that was the reason why we brought it forward. And just to be clear, what's really exciting about what we're doing is that we're able to keep our customers really focused on that FluroTec-based coding which as you think about the biologics growth of our business, and as it grows faster than any other part of our business, that volume requirement is going to be needed anyways within that unit. So we're really -- we're pleased by making sure it's in place and it's being ramped up, and we will be able to respond to demands that are in front of us, and that's why we pulled it forward.

Okay. Following up on that, you mentioned FluroTec there. That's one of your higher end high-value products. Why are these COVID vaccine developers choosing it? And will this trend continue on?

It's the complexity of the vaccine of itself, and it requires that bigger coating. And a lot of the companies that we're working -- most of the companies we're working with in their portfolio biologics, that technology, and they're very comfortable. And so as they're thinking, they're making their decisions on how to create their primary packaging containment from the elastomer side, West is one of the preferred choices therefore, that's why they're defaulting a lot to FluroTec and then in some cases, to NovaPure. There are a couple scenarios where -- as a past practices that would use standard material. For the most part, what we're seeing is FluroTec coating.

Got you. And then -- so given the COVID-19 requirements, is there a longer lead time for meeting non-COVID requirements?

No. So we've seen, in some cases, an increase on lead times, in some other cases, the decrease in lead times were made to order. And so -- but it's not a significant shift. With these investments that we've made, we'll see that all normalize. We are seeing that normalize at this point in time for our core business. And we're giving customer confidence as we think about order patterns, they're identifying that over the next 1 or 1.5 years, these are the demands they need. We're able to map that in. And give them confidence we'll have the capacity and the capability of producing and delivering on time. So that's the approach. And frankly, that's with the way the team is structured today and the last few years about market-led, that visibility is a lot more evident today than it was a number of years ago.

Got you. Maybe last one on COVID. How are you preparing for the various vaccination scenarios? If demand remains high, will West have to invest more capital or build more facilities to keep up with that demand, along with the underlying demand of injectable drugs? What is demand? Where does that fall in a widespread vaccination program is finished? And what will happen to all that expanded capacity?

I can take this one, Eric. Yes. So the capital that we've installed towards the back end of 2020 and that we're continuing to install in early 2021 was already baked into our 5-year strat plan. So we would have been on-boarding that capital probably in 2023 and maybe a little bit after that. So we do see growth in our core business, which has remained strong right throughout COVID, and we continue to support that. So there is an immediate need now with vaccines to use that equipment. However, if vaccines for some reason went away, and it wasn't a recurring business, that equipment wouldn't lie idle for that long because we do see a lot of increased demand around FluroTec and NovaPure, even in the normal course of business, excluding COVID, and that will consume that extra capacity that we're layering in, in a relatively short space of time. So from that impact, there isn't a big risk for us. On the other element, or the part of the question, do we need to add more capital? That is something we're continuously assessing. So we took a phased approach as to when we layer in capital to respond to COVID, primarily around vaccines. And based on working closely with our customers, we have good visibility on that. And we added about $40 million extra in 2020 and we do see some incremental capital around COVID in the early part of 2021. But as I said, this is -- it's a moving target. So as things become clearer, we'll decide whether we need to add more or not. But again, all of the capital that we would even be adding within 2021 is baked into our original and 5-year strat plan. So it will get used over some time. It's not that it will sit there for long periods of time not being used.

Got you. So maybe following up on our conversation about biologics earlier, what do you see as potential growth drivers for West's small molecule customers in your pharma and generics business units?

Yes. I'll take that one, Bernard. So when you think about the generics and the pharma, generics, we can see more of a long-term mid- to high single-digit grower. And the reason why we see this is because we're winning more and more of the ANDAs each year. And many of these customers are adopting the AccelTRA program that we launched a couple of years ago, which is part of the HVP program. And we're also seeing adoption of legacy formulations in the RS and HVP format. So we're actually quite excited. This is -- of the 3 market units within proprietary, this one had the lower market share, still very attractive. We continue to be a leader, but this is an opportunity to take more share. On the pharma side, that is more mature. Where we're seeing growth opportunity there has been from really new small molecule drugs coming from emerging pharma companies. So -- and for these drugs, we often see them adopt our higher-end coated HVPs. And last year, we launched a new formulation, a new product, and which is our most recent HVP formulation, that's really focused to that customer segment, and that appeals to the uncoated market. So it really is -- Casey, it's really tailored solutions to these segments. They are emerging as strong growth driver segments. It is the reason why we're getting above-market growth rates for those areas.

Okay. So as far as Vial2Bag goes, in 2019, you recalled your Vial2Bag administration system. In October of last year, you announced that you received FDA 510(k) clearance to re-enter the market there. Can you please describe how the launch has been? And what to expect from this product and family moving forward?

Yes. I can take that. So we returned to the market with the Vial2Bag, advanced 20 mL admixture device. So this is -- it's a universal needle-free admixture device for immediate use for IV infusion and enables the reconstitution and transfer of the drug between a vial and an IV bag. So as we've just got the 510(k) approval, we're in the early stages of the commercial launch and that's really again early in 2021. So it may take a little bit of time for us to get back to where we were before we recalled the product. But we're encouraged with the really positive perception that we've received from customers so far. And we really believe that we are assisting in the standardizing procedures for maximizing efficiency for point-of-care and nursing with this device so again, there's a lot of interest, a lot of pull from the market, and we're in the process of getting it back on to the market, and it is relaunched.

Okay. Maybe 1 on margin expansion. Can you just give us some details on drivers that West will use to drive incremental margin expansion over the next few years? Are there specific catalysts or watch outs that you could drive upside or downside to 100 bps per year of expansion you're targeting?

Yes. So the drivers have remained pretty similar to the ones that have been there for the last number of years, and there are multiple drivers. So the increase in high-value product sales is really the number 1 driver. So we see that really been tied to our biologics market units. And over the last number of years, we've seen solid growth in that area, and we continue to forecast that. And you can see it in products like NovaPure, CZ, some of the self-injection products and around FluroTec. So that is one of the main drivers, obviously, of revenue, but also of margin improvement. Then there's also an element of pricing where typically we get 1% to 2% on pricing per year, and we continue to see that over the next number of years. And pricing is an area that we are focusing on -- and to see where -- how can we take that and can we get above the 1% to 2%. And then on, as Eric mentioned earlier, it's around globalizing our operations and being able to get greater utilization from the infrastructure that we have put in place from a global perspective. And again, we've seen significant improvement on that over the last number of years but we still believe there's a lot we can get from it as we continue to introduce greater levels of automation, standardization, lean principles and agile methodologies across our network. So multiple drivers which gives us confidence to say that we can continue that improvement over a number of years.

Got it. And in this year, you guys accelerated your capital spending over your original guide due to COVID. It looks like 2021 could also see impact on pandemic CapEx there. What's the right way to think about CapEx spending post pandemic?

Well, prior to COVID, we were probably tracking about 6% to 7% of revenues on CapEx, and that was divided between maintenance CapEx, probably $40 million to $50 million, $10 million to $20 million on IT depending on what was required, and then the rest is really focused on growth. And that CapEx is primarily around adding equipment rather than footprint. So we have the infrastructure in place. It's just layering in equipment at this point. And what that does is it gives us a much faster return on investments and improves return on invested capital in an accelerated fashion compared to layering in buildings, et cetera. So that's where typically we would see it coming in. It's going to be higher, obviously, in 2020 based on increasing the spend by $40 million. And we potentially see some increased spend above what we would normally do in early 2021 and there may be some additional spend required later on in 2021. But that's all supported by growth, and it is to meet demand that's there in the market. It's not really speculative investment. It's to meet customer demand. And so that's typically the way we're looking at it.

Okay. Got you. And then maybe just touching on M&A. You guys have had a long track record of generating organic sales and expect to continue to do so. So based on your financial construct here, how does M&A fit into the picture moving forward?

Bernie, do you want me to take? I'll start with this.

You can start and then...

Yes. I think when you look at -- Casey, when you look at the opportunities that West has, you're absolutely correct. I think the previous number of years, we really focused on the organic growth, leveraging the strategy and making traction, and I think we've made great progress. I could add a point at this juncture is that we do have the opportunity to look at other technologies, license capabilities, equity investments and acquisitions, small bolt-on type of acquisitions to really help fulfill that complete offering to our customers as we think about continuously the containment and delivery of injectable medicines. So I think there's a good opportunity. We have focus in that area, making sure that we're ahead of the curve on the new technologies that have been developed by very small institutions and/or organizations because that's one thing that West is really good at is taking technology and now commercializing. And so there's an opportunity for us to start looking further in the growth strategy. So Bernie, do you want to round that up?

Yes. We take a pretty disciplined approach to looking at M&A. So we're in a pretty strong position that we have such a powerful organic growth story, and we're very cognizant of that. So we don't want to do anything to detract from that. What it allows us to take the appropriate amount of time to go and look at investments to assess the right targets and then to action them. But we can do it in our own. We don't have to rush into it. It's not that we've been forced into anything. So we need to make sure that we take that type of approach. And as Eric said, then it's looking at acquisitions across a number of different areas and a number of different methods of doing that. So again, it is more of a priority for us at this point. And I think I believe we're approaching it from a very strong position and looking at it the right way. And it's all about creating better offerings for our customers and patients and increasing the return for shareholders.

Got you. Okay. Well, it looks like we're hitting the top of the hour here now. So I guess we'll leave it at that. Thank you to both of you for presenting today. We appreciate your time, and thank you to everybody for joining us today.

Great. Thank you, Casey.

Thank you.