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

I am Juan Avendano. I am part of the life biosciences tools equity research team led by Derik De Bruin at Bank of America. I focus on biopharma services, namely CROs and CDMOs. I'd like to thank everyone on the webcast for their participation, and please feel free to submit your questions through Veracast. It is my pleasure to conduct the following fireside chat with West Pharmaceutical Services. We're joined by their CEO, Eric Green; their CFO, Bernard Birkett; and Quintin Lai from Investor Relations. Eric and team, thank you once again for being here. To set the stage, would you like to do a few opening remarks?

Yes. Juan, first of all, thank you for the opportunity to participate in your events. It's been a really good day for us. And I'll just add a couple of comments before we get into the Q&A. But when you think about since the start of the pandemic, our priorities have remained constant. We think about safety of our team, team members across the globe and also continuity of supply of the critical components needed by both our base customers but as well as a dynamic demand by our customers working on vaccines and therapeutics. I won't recap on 2020, but I'll kind of fast forward to Q1 and 2021. We continue to see strong high-value product growth in both our base business as well as accelerating demand of components used for COVID-19 applications. The high-value product sales growth led to strong gross and operating profit margin expansion, and we're very pleased by being able to leverage our operations globally as a network more effectively today than I would say what we had in the past. We're also completed with our first phase of capital expansion. We added capacity, started to inject into our operations at the end of 2020 and obviously validated. And now we're able to produce commercial product. We're almost completed with the first phase. Second phase is occurring through the back of 2021 and into 2022. And then we're currently under another consideration of another phase as we gain more visibility in really 2 key areas. One is productivity gains for our first 2 phases and also sustained demand of COVID-19, which would mean that we'd need more capacity to address our growing underlying base business. Just to summarize, though, the focus of the organization is really around execute. It's around innovating. It's also around growing. I believe the organization is performing quite well at this moment even under these uncertain times. So I'll end with that, Juan. I hope that's -- gives some context about where we are today. And I know Bernard and I would -- and Quintin would like to field any questions you may have.

That's good. Appreciate the opening remarks. So let's just go ahead and dive right into COVID-19. In the initial rollout of COVID-19 vaccine, it has been generally carried out in multi-dose vials. But based on comments during your last earnings call, in line with our channel checks, there's a chance the future of vaccine doses and potential booster shots could be administered in fewer dose vials and even single-dose prefilled syringes. Could you provide more color on this evolving dynamic? What is the potential benefit to us? And ultimately, what are your thoughts on how durable the COVID-19 business could be?

Yes. You're right. In today's environment, the COVID-19 vaccines are administered in multiple doses, as you rightly said. It's ranging anywhere from 5 to 14 doses per vial. And our business, we're really focused on number of units versus per dose. And the situation continues to be dynamic and fluid. Everybody knows the vaccination rates are still ramping, are yet to be ramped in certain countries across the globe. And we are -- and yes, we are hearing that boosters and annual shots through conversations with our customers may be required in the future. So these could be development packaging that looks more like flu than the mass vaccination strategies, what we see today. And therefore, you're looking at less dose per vial or being packaged in a prefilled syringe format. And I'll give you an example. When you think about the typical flu shot today in the marketplace, comes in various forms such as prefilled syringe, one for the adult and one for the children age. You have single-dose files and you have multi-dose files. So the configurations could change from what we're dealing with today. It could be quite different. So we believe, based on what we're seeing and work with our customers that, that change will occur, but it's going to take time. And hence, the discussions we're having internally on what additional capital would we be required to put into our manufacturing facilities to handle potential increase in demand.

Sure. And I believe the majority of your COVID-19 business is related to vaccines. But can you give us an update on what is going on with the packaging component sales related to COVID-19 therapeutics? Have you seen a slowdown since the vaccine rollout?

There hasn't been much of a change in regards to therapeutics. So we're obviously still participating on all the therapeutics in the marketplace. But you're absolutely correct. Majority of the volume that we are currently producing and shipping to our customers is around the vaccine solution.

Good. And sort of like a topic du jour lately, I mean, last week, it was reported that the U.S. would support waiving patent protections for COVID-19 vaccine. Can you give us your thoughts on this matter? And does this have any potential follow-through impact from your customers on to West?

Yes. It's difficult to comment on the, I call, hypothetical policies, and I know that, that's only been discussed for the last week. From our perspective, when you think about our materials, we are the global leader for elastomeric primary packaging for injectable medicines. And we work with customers across the globe ranging from large pharma, generics and emerging companies. And it really is around the science, quality and scale. So you think about the compatibility of the drug molecule with the primary packaging containment, and we -- that's what we're focused on. That's what we can give assurance to our customers. But in regards to the IP discussion, it's hard to comment at this point in time.

I understand. Moving on to the financial performance and guidance of the company. In the first quarter, West generated $103 million in COVID-19 related revenue. Even when you exclude the $12 million onetimer fee that you called out in the earnings call, your current guidance, which assumes $345 million in COVID-19 revenue this year implies no sequential pickup in quarters to come. So can you help us understand why is this the case when COVID-19 vaccine manufacturing activity is scheduled to increase as the year goes by?

I want to pull Bernard into this conversation. So Bernard, can you address that?

Yes, sure. We're giving guidance based on what we're seeing in our business at the moment. And we think that $345 million number is pretty solid. There's a couple of factors that we're kind of baking into that as well as when we look out at Q3 and Q4. And particularly, those quarters, from a revenue perspective, it's sometimes a little bit lighter for us because we have planned shutdowns, particularly in Europe, for a number of weeks in August so that we maintain our plants. So there may be a slight drag there. And then again, in December time frame, you've got less production days. So you got to better take that into account as we move into the holiday period. And so we've been factoring that in. Now if there is greater demand than what we have forecasted, we have the capacity put in place to be able to meet that based on the earlier comments about layering in capacity in various phases with some of it coming on board in 2021 and then the rest in 2022. So that was the thinking behind the guidance. We just didn't take a number from Q1 and extrapolate it out over the year. There were a number of different factors there. And plus, this whole situation in response to vaccines is evolving as we speak. So I think it was kind of prudent to guide in the way we have.

I appreciate that. And then you've spoken a little bit about capacity, and so let me just go ahead and jump on that topic. And so you had to expand manufacturing capacity in order to support -- for high-value products in order to support COVID-19 demand. You've hinted at this, but can you just give us a quick summary of your capacity expansion plans? What's been completed, what's still in the works? And how should we think about CapEx as a percentage of revenue on a normalized basis going forward?

So the way we look at CapEx, particularly in response to this pandemic, we've done it on a phased basis. So we started last April in 2020. We looked at how the market was developing and how vaccines were being developed. We put extra capacity in place, particularly around FluroTec, where we saw a lot of interest, and around NovaPure. And that capacity, we started layering in towards the back end of 2021, but the equipment validated and some of it was actually in production by the end of the year. We're continuing to finish that first phase. And as we got to the back end of 2020, we came to the conclusion that we needed to add more CapEx, particularly for the latter part of 2022 and into 2023 based on what we were seeing. And again, it's not just for vaccine business. It was really to support our core growth, which we were seeing in those, specifically around high-value products and then the vaccine element on top. And we're really layering in, replicating equipment that we already have in place, so we're not adding any new technology. So it -- pretty straightforward for us. It's just the speed that we're operating at and the volume we're putting in at one time. And again, it is all equipment. It's not bricks-and-mortar at this point. So it has been pretty quick, and it's been right across our high-value product plants across our network, so in multiple geographic locations. And so at this point now, we're looking at -- potentially looking at Phase III based on some of the comments that Eric made earlier about how the market is evolving, how vaccines will be -- could potentially be delivered in the future. So we have to assess that. We haven't come to any conclusions yet. We're working that through. So that's why -- how we've managed it. So our CapEx as a percentage of sales has peaked in 2020 and in 2021. On a normalized basis, we typically see about 6% to 7% of revenues being deployed on CapEx and to support growth within our normalized construct of about 6% to 8%. But also one of the things that we have to kind of understand as well is the growth profile of our business has shifted over the last couple of years, where we had seen double-digit growth in Contract Manufacturing for a number of years and then probably less than double-digit growth in our Proprietary business. Now we're seeing both in our core business and vaccine-related response. Biologics has become the main driver of growth within our business and that's by design. And so that, along with the kind of normalized growth we see in generics and pharma, leads to a different mix shift, which has kind of helped us decide on where we need to deploy capital and to generate faster returns.

On one point that you brought up, that essentially biologics being been a major driver of and reason as to why you're adding capacity, could you break up the component that is associated with new product approval volumes versus conversion within high-value products that go into biologics based on what you've seen recently?

Within -- I can start, Eric, and then if you want to comment. Within biologics, it's primarily all new business. It's predominantly around high-value products. So as soon as somebody enters that space, they're going on to a high-value product. And what we're seeing now is that more and more people are gravitating towards NovaPure towards the higher end of that spectrum.

Again, the first -- when you think about the first 4 months of this year, we mentioned that we're over 95% participation rate on the new biologics, approved in Europe and also the United States. And Bernard's absolutely correct. As you think about the seeding of NovaPure, we started that journey back in 2016, 2017, takes about 2 years to really -- to penetrate into the new pipeline. We do start early, and we're seeing the benefit now. And that's where the demand is picking up. So it's new drug launches, but it's also -- we're seeing our customers' drug molecules getting a higher acceptance rate into the market, and that's growing also. So it's kind of a compounding effect. So we're very pleased with the pull effect that we're having right now, particularly in biologics with the high-value products.

Understood. And has there been any specific regulatory tailwind that has sort of supported the high-value product conversion? Or how do you see trends in the regulatory landscape in the packaging space?

Well, it's in our favor, frankly, when the regulatory landscape gets more complex. I mean I know there's obviously some changes that are underway with USP. I think about, particularly around, I think it's USP 381. It's -- I'm being specific here. But the physical, chemical series. And what this is all about, it's really -- functionality testing must be looked at from a system approach and based on the actual drug applications. So this benefits us in really -- and we think about it in 2 ways. One is all testing must be completed on the components in their finished form, meaning ready to use. And you've heard us talk about Westar RU, NovaPure RU, that's ready to use. So as we continue to introduce these products to our customers, they're already in that format, which allows easy adoption with these regulations. And the second is really, we have -- just over my shoulder actually, we have a very robust analytical service laboratory, which we can help facilitate this kind of qualification testing for our customers. And this really simplifies our ability to get drug application-specific testing completed and filed. So -- and that's West -- it's one of the core competencies of West, and we are able to differentiate on that. So you're right. There's other regulations like ISO standards and ICH guidance. They're all -- they're changing, but that is in our favor. And as we develop our high-value product portfolio, we're able to encompass those requirements and make it much more value proposition for our customers.

Going back to guidance a little bit. I mean, your base business has accelerated significantly. West delivered 10% organic growth in 2019 and 11% organic growth in 2020, excluding COVID. Do you believe that your long-term target of 6% to 8% organic revenue growth is still appropriate? Why or why not?

We'll let Bernard address that one.

Yes. It's still appropriate. I think when you look at the growth trajectory of the various parts of our business, it ties -- it gets us to that 6% to 8%. So if we can do greater than 6% to 8%, great. We'll obviously strive to do that. But as I mentioned earlier as well, our CM business, where we were seeing this double-digit growth, that's going to come down. That is at mid-single-digit growth, and that's where we'd expect it to be. Our Pharma business is typically low single digit to mid-single digits. Generic, mid-single to high. And then biologics is high single digit to double-digit growth. And so when you combine all those factors at the moment, we're seeing, on a normalized basis, if you strip out COVID, you're getting to that 6% to 8% growth rate. And then the other thing you got to consider, this is -- that 6% to 8% is not much larger numbers than it has been in past. And even if you look at the acceleration over the last like 1 to 2 years, that the step-up in revenue has been pretty considerable. So to grow to 6% to 8% of that number is something a little bit different. Plus with the opportunity to continue to expand operating margin by 100 basis points plus, again, on those larger numbers, is -- we're confident in our ability to do it. And we're confident in the 6% to 8% in the long-term outlook with that. And at this stage, to kind of commit to anything higher, I don't think is -- it's not the right time for us.

I understand. Moving on to the cost structure and inflation and margins, given the last statement that you had, you've done quite well on margin expansion. I mean West expanded adjusted operating margin by 330 basis points last year and could do even better this year. So I have a couple of questions on this. First, are you seeing any notable margin pressures from labor, logistics or higher elastomer raw material costs from the increasing oil prices? And can you pass all of these costs onto your customers or what proportion?

So on the labor front, there are some pressures with labor. It's well documented. To this point, we've been able to hire the people we needed to hire, and that's globally. So at each of our plants, we've been adding headcount as the volume increases have been coming through. So we have a very, very strong HR network in place to be able to attract those employees on board. And plus, when we're bringing people on board, it's -- really, people understand the importance of what we at West do and how we're supporting the pharma industry. So that's kind of an added advantage when we're getting people to come on board. On the wage inflation side, we have seen it in certain locations, and we've been able to offset that with greater levels of efficiency and productivity. And also by being able to run some of our plants in certain areas within those plants 24/7, we're getting better operating leverage. So that helps us offset some of those increased costs. On the material side, yes, there are increases. Some of them, we can pass on to customers within and after a 90-day period, so it rolls for a quarter and we pass them on. And then we have some hedging instruments in place around some sort of -- around some raw materials, particularly oil-based. So it's -- these are just other challenges we have to manage. I don't see them being overly material, having a negative impact on our margins as we move forward that we've been able to absorb them. We also absorbed the increased costs around logistics, around PPE, around keeping plants running 24/7 throughout the last year. And it's really, again, how efficient we can be through our plants helps absorb some of these.

And on this topic, last week, I mean, Aptar, one of your competitors, actually announced a 5% price increase across other product lines in order to offset inflation in raw material costs and labor. For West, what magnitude of price increase is embedded in your 2021 guidance? And what's the upside potential to this projection?

So typically, we're 1% to 2% for price. So we don't get price on all aspects of our business. We get it in certain sections. Within those segments, it's going to be north of that, obviously, 2%, but on average, 1% to 2%.

Good. And then lastly, on the margin profile, outside of the margin expansion that you typically get through your high-value product mix, at one point, that might not get so much attention as the solid margin improvement in the Contract Manufactured Products segment that happened over the last year. Can you remind us about the opportunities and initiatives to drive margin expansion in this segment? And how could the segment's -- how high could the segment's gross margin ultimately go?

Yes. I believe the opportunity for margin improvement within Contract Manufacturing, it's going to be less than what we -- what's available to us in our Proprietary business, just by the nature of the business. We've said in the past that if we got to 19%, 20% margin on that business, I think that's where it can go. We've made a lot of improvements over the last 18 months in getting closer to that number, but there's still some work to do in that area. And it's really around increased levels of efficiency and automation. But we're on the right track, and we have been making the improvements. So we expect to see that continue. I would see more of that in the second half of this year rather than the first half.

Okay. Good. Moving on to the balance sheet and capital deployment, I mean, West has a very strong balance sheet with a net cash position that is growing faster as your revenue growth and profitability have picked up. Aside from organic investments, CapEx, the dividend and buybacks, what else are you planning to do with this cash?

There's not a lot left after those 3 things. It really -- M&A is becoming a greater focus for us. It was important for us over the last number of years to really get consistent and that sustainable growth within the core business, organic business. And we have done that and delivered the increased levels of profitability at the same time. So now we are going to look more at M&A. But we're in a position where we don't have to rush in to do it. We still got a very, very strong organic pipeline, and that's our main focus. We don't want to do anything that will destabilize that. So we're looking at a couple of different options in a couple of different areas. How do we support our customers on the packaging side? Are there other support we can give them, provide them with better service and products? And then also looking on the injectables and wearable sites that there are areas that we can start to explore in more depth at this point. But it's really making sure that we go after the right targets. And when we do that, we can create value from them rather than just doing an acquisition for the sake of doing an acquisition. We don't need to do that. So I think given the strength of the organic growth story and the balance sheet, it's prudent to, again, take our time and wait for the right opportunities. And when they present themselves, we'll be ready. Go ahead, Eric, if you want to add more to that.

I think that was well said.

Switching topics a little bit, I mean, onto ESG if we may. I mean many investors are increasingly using ESG criteria to make investment decisions. What are some of the ESG attributes of your company and ESG initiatives that are being undertaken?

Yes. No, Juan, it's -- there's much more discussion going on today than in the past. You're absolutely correct. And when we talk about the One West culture, it encapsulates many things, including continuous improvement basically in everything that we do and [ else ] being a great team member amongst one another. And they create a great workplace to work and give back to our communities. In other words, it really is -- we believe that West should be a strong corporate citizen, and ESG exemplifies many of these aspects. In 2017, we created our first set of 5-year ESG initiatives. And we announced that we exceeded those goals just in 3 years. And so end of 2019, early 2020, we relaunched, reset the next 5-year targets with even larger expectations. And we're confident we're making good progress towards achieving or exceeding those targets, particularly around waste, energy and water usage. When we think about -- we continue to reaffirm our commitment towards the One West team, value that calls really on all of us to respect one another, drive collaboration, embrace diversity, inclusion in our workplace. And we do make -- we continue to make strides in this area throughout the whole organization from new team members being hired at all levels in our manufacturing sites to a diverse representation really on our executive leadership team here at West. So we are releasing our corporate responsibility report in a couple of months, and there'll be even more information provided later this year. So stay tuned. But it's -- I can assure you, ESG has been and still is part of the DNA of this company.

That is very important. And I guess one last closing question. This is going to be on competition. And so one of your competitors has made remarks on gaining share during this pandemic. How would you compare your competitive position in your market share now in relation to what it was before the pandemic? And also, do you see any structural changes in the market post-COVID that could either benefit or impact West?

Yes. I won't comment on competition, but I will say that we remain focused. You know that we launched the market-led strategy a few years ago, and that is really taking shape. We continue to make good progress, which meet the present and the future needs of our customers, their patients, and you mentioned this earlier, the rising regulatory standards across the globe. So I think we're very well positioned. One of the barometers we use here internally is what's our participation or win rate on new molecules that are being launched, whether it's small molecule or large molecule, could be a biologic, could be a biosimilar. I mean it's very, very high. In fact, and I've kind of articulated more recently, but the numbers continue to go north. So that tells us that we are resonating with our customers of the value propositions of the new launches, the extensions of our products and driving service, driving quality and driving that assurance when they put that drug molecule in the market. With our product, they're assured of the highest level of standards in the industry. So that's what we're focused on. I think the pandemic has driven more agility, and it has allowed us to leverage our global operations more effectively. There isn't anybody in the space that has as much volume that's going through the plants as West. And we're able to leverage that more effectively today than we were in the past because of the -- I would say, driven by a lot of the pandemic decisions that have been made. So I'll stop on that one. I know we're out of time, but hopefully, that addresses your question.

Yes, it did. Well -- and with that, I mean, Eric, Bernard and Quintin, thank you once again. And for everybody on the webcast, thank you for your participation, and we would appreciate your support in the upcoming II voting. This is the end. Thank you.

Thank you.

Thank you, Juan.

Thank you.