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

Good afternoon or good evening, folks. Welcome to our Jefferies London Healthcare Conference. We're taking virtual conference to the next level here with people in multiple different locations. I'm Dave Windley, I'm an health care equity research for Jefferies, cover the pharma services and supply chain area for Jefferies. And one of those companies is West Pharma Services, ticker is WST. The company has had an extraordinary run for multiple years, helped by COVID but not exclusively COVID, and we'll get into that. I want to introduce the company's representatives there's Chief Executive Officer, Eric Green, and the company's Chief Financial Officer, Bernard Birkett. I want to welcome you guys to the conference. I appreciate your support of the conference and making the trip. I know Bernard was over there for multiple reasons. And Eric, I appreciate you joining us. So thanks very much for your time.

No. Thanks, Dave. It's great to be here in London. It looks like a great turnout and the day has been very beneficial. So thanks for your invitation, Dave.

Yes. Yes. Excellent. Excellent. Well, thank you very much again. So Eric, let's just jump in. The company, as I mentioned, has had a really strong growth path for a few years now, maybe supercharged by some of the volume and benefits of COVID vaccine, but really growth of 29% total and still 15% or so ex that COVID benefit, both numbers really, really strong. Maybe you could talk about the drivers of those and the sustainability of that growth trend?

Yes, right, Dave and I think we've been seeing over the last several quarters, consistent growth and performance of the organization. And I'm actually -- truly believe that the approach we've taken on the market-led approach has given us better visibility into the discrete segments that we focus on. When you think about the biologics, the pharma, the small molecules and also the generics. But your overall business this year, year-to-date, as you said, it was growing roughly around 30%. And about half of that incremental growth is attributed to COVID-19 and the balance is really the core business and continuation of success. Let me break it apart a little bit more. I think COVID-19 response is basically our participation on the vaccines that are available in the marketplace. What we're seeing is the adoption of FluroTec and NovaPure our highest level quality of the high-value product portfolio because of the sensitivity of the molecules that are being used in the vaccines. So we continue to invest, and we're able to continue to build to supply vaccine community for the fight against COVID. Now on the core business, double-digit growth is considerably more than what we have historically have done, but this has been ramped up. And I think you can see this in the trends. The key driver of that basically is around the biologic space. You think about our participation rate on the products that have been approved over the last recent years, the adoption towards our highest level quality product, which is NovaPure, which gives us the best economics within the high-value product portfolio. And you think about the uptake of those biologic drug molecules into the marketplace and replenishing and supporting our customers globally. So as we think about the growth, the biologics is key driver of the double-digit growth, and it's becoming considerable part of the size of the overall business. When you think about over 40% of our business, consolidated business is towards our biologic customers, again, growing quite well. I think if you pair it back a little bit more the generics and the pharma area has been growing nearly double digits in the last couple of quarters. And a lot of that really is a little bit of a comp issue there. But again, it's penetration, the win ratio of the new molecules and success in those areas. So overall, continue to see great progress in all areas of the business.

That's very helpful. You mentioned -- I want to dig in on a couple of points there. You mentioned 40% of the business now Biologics, that has increased significantly over maybe the last couple 3 years. Does that include -- are you classifying the vaccines in that business unit as well?

Yes. Yes. majority, not all of the transactions we have are classified with biologics.

Got it. Okay. And within Biologics, you mentioned NovaPure. One of the things that has been interesting, I think, in watching the business grow and develop over now, I guess, close to 10 years for me, is that the strategy to move clients to high-value products has been consistent. That evolution has moved steadily, albeit maybe slowly and the move has been into a variety of those products, Westar RS, RU, Envision et cetera. But it does seem like in the last couple, 3 years, the willingness to step up to your highest quality products has been higher. And that's even -- COVID has boosted that. But even ex COVID, that seems to be true. Could you talk about whether -- is that kind of an additional regulatory push? Is that client quality desire? Is that a supply availability capacity that you have put in place? Is it perhaps the convergence of all of those things? Maybe you could talk about why the step up to the highest quality.

Yes. So I think it's a little bit of everything you described. But the biggest driver as we think about it, it's specifically a NovaPure platform. When you think about the introduction of that quality by design solution, really, the introduction was around the 2016. As you think about in the space that we occupy, it does take a couple of years for adoption for our customers to get comfortable through testing, through stability tests, through looking -- developing the scientific data to be able to support a filing. And as we seeded the market, you're starting to see that now become reality into late-stage development, but mostly into commercialization. And it was a two-pronged approach. The one is obviously the large biologic customers, getting them comfortable with this platform and moving their new molecules towards the NovaPure. But also what you'll find in -- from our view, in the biologics space, there's a tremendous amount of innovation going on with the smaller biotech firms, whether it be 2 individuals or multiple individuals. And what they're looking for is that scientific knowledge about how do I do the primary packaging containment. And so what we are doing, we have been seeding that particular space with NovaPure, quality by design to eliminate all the potential risks that they may inherit by providing the full dossier and technical support for them to get through the filings. So it's a two-pronged approach, but that is what you're seeing, Dave, when we sort of think about the win ratio we have, how many of the new molecules are being approved that are on NovaPure and how our customers want to create that as more of a platform approach versus selective. And so at this point in time, we'll probably get in greater detail about capacity expansion. But we need more capacity in that area, which we're responding to. And that will help us continue with this accelerated growth of that part of the portfolio.

Interesting. So flipping to the -- maybe the other side, the COVID side of the discussion here. Bernard, you have guided to about -- around $450 million of COVID revenue for fiscal year '21. You've seen relatively similar contributions in the $115-ish million range the last couple of quarters and the fourth quarter implication looks like about the same. Is that kind of a steady run rate for the foreseeable future? What's magic about $115 million these days?

Well, it's based on a number of factors. We have to balance a number of inputs into how we put that forecast together. And then how we supply around COVID vaccine. So we're looking at the installed base of capacity we have. We look at the demand for COVID vaccines, but we're also looking at the demand coming from our core business and trying to balance all of those contributors. And so when we look at us to supply the current needs of the vaccine market, it is about that figure, and it has been relatively steady over the last number of quarters. What we're also doing is adding additional capacity around NovaPure and FluroTec. And we've been doing this since 2020. And we continue to layer that in as we move into the latter stages of 2021 and into 2022. So that's the run rate for now. But I think over time, that run rate could change.

Okay. A decent segue into my next question, which is that the COVID vaccine developers, it seems like it's been a part of the discussion for the better part of this year that the expectation is the manufacturers will move to a different format, perhaps a lower dose or a single dose vial or a single-dose prefilled syringe. What are the implications of that to West production?

Yes, David, as you think about number of -- I mean we're basically focused on number of units. So as lower doses per vial, as an example, that would actually -- assuming patient population remains static that would require us to actually increase production. Again, because of the type of vaccines we're dealing with are really focused on the FluroTec and NovaPure. So that would -- the implications to less production would be increasing volume. And hence, the announcements we made about Phase II -- or I'm sorry, Phase III and Phase IV investments, which is all around that part of our portfolio. I think the first part of the phase is more around stoppers and the second part of that investment is around plungers. Again, to support COVID-19 pandemic, but also to support our core business as we go forward. Yes.

Interesting. So on that point on the stopper then plunger eventually, is it -- do you begin to have any visibility at this point on how much of the production might move to this lower dose format or single dose format. And by that, I mean, in conversations that we're having, it seems that different parts of the world -- or we should think about differently like the developed Western world that is going to maybe less frequent booster dosing would need single dose, but say, the developing world might still be in a multi-dose vial. Do you have thoughts or visibility to how we should think about that splitting out?

Yes, Dave, we -- as we have discussions with our customers, which is helping us shape the investment thesis of when to make these incremental investments, again, particularly around this part of the portfolio. We do have some insights, but we -- I would prefer our customers kind of articulate timing and how much. I will say that, again, these investments we're making, yes, they're part of the core, but also with COVID. And we're making these best -- based on the best available information we have in discussions directly with our customers. And that's probably as much as I can probably articulate. But your thought about in more developed markets versus markets that the penetration of these vaccines haven't reached, yes. I mean there's different strategies that they will partake and make sure that everyone has access and there are going to be a different cycles over the coming periods of time. So fortunately, at West, we have scale. We have the right portfolio. We're making the right investments so we can support these investments. And also, fortunately, is that the solutions we provided in COVID-19 are exactly the same part of the portfolio that's fueling the growth in the core biologics. So you can see how this is nicely coming together. It gives us great confidence that these investments are being made at the right time so that we don't become a bottleneck with our clients.

Right. Understood. And then maybe a last question on this topic. You mentioned stopper than the focus on plunger would be after that. Is West financially indifferent between a stopper for a 1 or 2 dose vial versus a plunger for a prefilled syringe?

Yes. The way to look at is that the economics between a plunger and a stopper for West is relative the same 1:1. So -- and again, based on units. So 1 unit of a stopper equals basically 1 unit of a plunger. So I'll leave it to that. And then you can do the math from there on potentially the kind of a multiplier effect as you go to less doses per unit.

Yes. Okay. So moving on to maybe the cost side of the equation and margin. Management is committed to 100 basis points of margin expansion annually as a long-term construct. You're set to surpass that pretty handily, very handily this year, but you surpassed that or will have surpassed that for 3 years in a row I think. On the 3Q call, you did mention plans to continue to expand margins so you're not done yet. Can you talk about your views and your optimism about continuing to expand margin?

Yes. So when we look at margin, again, it's that there are multiple factors to how we drive that improvement over a sustainable period of time. And the first is on mix. So as we -- you can see where we're investing in our business, it's in high-growth areas, it's around high-value products. And the continued growth of that segment will feed into the margin expansion that we're forecasting out for the next number of years. And we've also got an element of price that we take each year. So it's 1% to 2% increase across our portfolio. And then from an operational side, we continue to drive higher levels of automation and greater levels of efficiency across a number of our plants. And we're seeing higher levels of utilization, and we are now running a number of plants 24/7. So we're picking up efficiencies there. And on the cost side, what we've seen is that we have seen increases in material costs and in some of our overhead costs and labor and with the material costs, we typically pass those on to our customer. And there's usually a lag of maybe 1 to 2 quarters before that takes place. But from what we're seeing now, it's not overly material for us. And even if we have to absorb some of it, we can. On the labor side, we're offsetting the increase in labor costs with greater levels of efficiency and also with the introduction of more automation within our business. And then with overhead costs, again, with some of those based on the contracts that are in place with customers we're able to pass on some of that cost. So it's -- so that gives us confidence based on how we're able to deal with that plus the mix shift and the pricing that we can continue to say that we'll grow margin at 100 basis points plus for a number of years.

Excellent. And then we've kind of touched on how COVID volumes in the move to lower dose formats might not go down, might even go up. But as you think about the margin in the COVID portion of the portfolio, the COVID portion of your revenue stream, is it fairly comparable to the rest of your business? Or as the rest of your business is certainly probably going to be the bigger growth driver long term, we hope from a societal standpoint, again, how do those margins compare between COVID and non-COVID?

Yes. So on the COVID and non-COVID parts of our business. They're both occurring primarily within biologics, and also within the same product platforms. So the margin that we're experiencing in our core business versus our COVID business, it's pretty similar. And again, that's where if you kind of -- if you see where the investments are going, it's all into -- much of it is into that space, and it is all around growth.

Got it. Eric, you correctly anticipated that we'd come back around to capacity. We -- you've announced -- gosh, 4 or is it now 5, I think, 4 tranches of high-value product production capacity accelerations of investment, and you've reiterated the point that these are all kind of on the critical path of your business, not deviating from what your core competencies are, but just adding to. The first of those, I think was -- the first of those tranches was completed in early '21. You talked about the second coming online in year-end '21 or near year-end. Could you talk about the timing of that? How is that doing? And then what would be the timing of the third and fourth behind that?

Yes, Dave, you're right. We have kind of pieced apart the different investments we needed to make. And we want to make sure that we were pacing at the right at the right time. So again, we stay ahead of the curve, but we're not getting too far ahead of ourselves. So it's a balancing act. And you're absolutely correct. The Phase 1 really was earlier parts of 2021, I've been actually quite pleasantly astonished, frankly, of how well the teams across the globe organized and were able to have our suppliers build the capital, the equipment bring it into our sites, innovative ways, have it installed, validated and our customers supporting the turn on to commercial production. And the -- because of the demand that we're holding today is that we are -- when the equipment is running, it is almost, I would say, clear to close to fully utilized at day 1. So it's a very quick start-up, and ramp up. And you can just imagine our utilization rate of this new equipment is quite high. Now Phase 2 is coming to completion it's different stages throughout 2021, but we're seeing that kind of close out as we speak. And so you'll see the commercial volumes continue to ramp up and go into 2022. The Phase III that we announced a while back is currently coming in and we're looking at installation throughout 2022, starting the first quarter and going throughout the year, but most of the first 3 quarters. In Phase IV, so the Phase III is really around stoppers. Again, FluroTec and NovaPure capabilities. And Phase IV that we've articulated is really around NovaPure plungers. And so that volume is more towards clearly end of 2022, but mostly 2023 and commercialization in 2023 to support ongoing. I think, Dave, just to reiterate, I think you summarized it well. But the investments we're making, again are really targeted to a very narrow area of our portfolio, and that portfolio tends to be the key -- the pull effect from our customers in the biologics space. So we think about keeping ahead on the COVID demand. And as things evolve and shift in potentially lower doses per unit on a vial or going towards a prefilled syringe, we're able to respond, and we're able to continue to respond as we have been over the last 18 to 24 months. But more importantly, in addition to that, is that these assets are capable to support the growth of biologics. And as we think long term the next 3 to 5 years, these were already in our plans for the core part of our business. So we are literally bringing it forward. So I'm very, very confident in these investments. And I would love to see COVID go away throughout the world, but these investments will not sit idle. If there was 0 production going on to support COVID, if you think about 1 or 2 years out. So I'm very confident in these decisions that the team have made.

So you made the point about how expeditiously not only your own people, but suppliers were able to build the machines, get them in place, validated, et cetera. Has that shortened what would have traditionally been your time line to put new capacity in place? And is that a permanently improved cycle time? And how does that impact your -- the lead times that you trying to keep lead time short to your clients, is there a virtuous cycle to that over the long term of the business?

Yes. The first 2 answers to your first 1 is yes and yes. It was -- is actually the cycle time to get the initial equipment in is much shorter than it has been historically. And again, the teams used innovative ways to move these pieces of equipment from other contents into the key locations as we needed to expand, particularly in the United States, and they would cut literally a few months off the process, and then the installation validation and the commercialization, a few months were cut off in that process. So to answer your second part of the question is that that's the new bar, that's new expectation here at West and we will continue to run as such because what we're finding is that we're able to have a quicker turnaround time of capital expansion versus having this long lead time and having it said potentially idle until we get the volume and capacity through our facilities. I do also think it is -- you're absolutely correct. Right now, our demand is considerably high. And hence, the reason why we've been making these investments. Our whole focus is to ensure that we continuously drive down cycle time. So where we do make to order for a majority of our transactions with our customers. They have given us lead time. We have confirm orders for the next 12 or 24 months as elongated, if you think about historically at West a number of years ago, it was a much shorter period of time, working with our customers, they've been giving us greater visibility so we can plan more appropriately. We can deliver in a timely fashion. And if things need to adjust, plus or minus, we can support our customers to have that accomplished. So it really is driving that service mentality to the next level. So I think these investments are coming in at the right time. And if demands do continue to increase, we are not opposed to continue to make these investments in addition to what we do typically is 6% to 7% of our sales of capital because, again, we're seeing the returns. We're seeing the commitments we're gaining from our customers. And we are the market leaders in this space, and we are not going to create an issue on supply chain.

Got it. Last 1 on capacity. With the 4, is there a rule of thumb in terms of when you pull the trigger, how much incremental capacity you're adding like either measured in units or percentage of sales that each of these represent?

Yes. No. Actually, what we tend to look at is about 80% utilization. It gives you enough room to have an increase and some volatility in your production operations. And also, and it gives you a lead time, obviously, to get additional equipment and I would say in this part of the portfolio, we were nowhere near that. When we started to ramp up these products. And as the biologics continue to grow the core, but also COVID, it's required us to move faster. We're hitting a 100%. Our plants are working 24/7. We continue -- we will continue to operate under such conditions as we go forward. But I think the other aspect that I'm very proud of is the team have implemented a very strong digital strategy in our organization. Historically, it required weeks and months and spreadsheets and numerous people to determine what is the utilization rate of each piece of equipment. Today through new technology that we acquired, it's through our own digital team. We have detailed data from each piece of equipment in all operations across the globe and gives us confidence that now we have -- we can respond quicker, more effectively and apply the capital at the right time.

Let's spend a minute on contract manufacturing, that segment has been -- went through a period of very attractive growth, I think, in support of continuous glucose monitoring end market. You also had been focused on trying to expand the margin there, which you did a couple of hundred basis points from '18 -- 2018 to 2020. In 2021, that's backed off a little bit. Maybe you could talk about the factors influencing the margin in the CM business?

Do you want to address this?

Yes. So we would expect the margins to get back to where they were prior to 2021. What we have experienced during the course of 2021 is pressure on some of our material prices on resins. But what we're now -- and that we've seen a lag between this occurring and when we can pass them on. And now we're in a position to pass those on to our customers and that's actually taking place. So we would expect to be able to get to that high-teen margin level within contract manufacturing. And we have seen the revenue growth rates moderate compared to where they were a number of years ago. And essentially, that's by design. We would like this division to grow within our construct of 6% to 8% given -- and that helps us manage the mix within our business, and that ties in then to the 100 basis points margin improvement.

Understood. Last question for me is the -- is coming back to capital deployment. So we talked about organic capacity expansions. That's certainly an area that you put more capital against in the last 1.5 years or 2. The M&A topic for you comes up periodically clearly not something that you're not making an acquisition every quarter, but you do express an interest in pursuing that if the opportunities present themselves. Maybe you could talk about your appetite, the types of things that you'd like to fold into the portfolio.

I'll start and then maybe, Bernard, you can. So Dave, I would say if I look back a little bit in the last 4 or 5 years, our whole focus really was to really get this market-led strategy and organic growth story, solidified, embedded and progress on globalization, progress on digitization. And I think what we're seeing today, especially during this time of the pandemic where the volume of demand has increased significantly. The team has responded. And I do truly believe, if I just want to add a comment as you think about this whole globalization. We talk about adding capacity. Now we've created a network -- global network with our customers that we can level load our operations more effectively because our customers are able to -- when they file with our products, be able to look at the process versus site-specific. So we have the opportunity to leverage our sites more effectively and we're seeing that, and we're able to respond to these type of demand surges that we've been dealing with. And so that was our focus over the last 4 or 5 years, and we're in a very comfortable position now, and we are generating more of free cash in this organization. I do believe, based on our customer insights and the conversations we're having with them. There's some pretty complex problems they're trying to solve. And we're being brought into the equation. In fact, many times, we're being asked to help them identify what is the future containment look like. And while we might be only a component of it, but they're asking for our input and guidance when you look at it holistically. So I just want to start with that because I do think there are areas that our customers are pulling us into and we need to be able to respond with a more complete solution to be able to support them long term. So we have made some changes in some focus areas within our with our organization. And Bernard, if you want to touch on.

Yes. So we've added a corporate development team or in the process of adding a corporate development team to focus specifically on this area. And we are going to become more active in the space. As Eric said, the organic growth story now is in place, and we've got that embedded. So the next thing to look for us to do is look at acquisitions partnerships, tuck-ins to add to the overall portfolio, both on the containment side but also looking at wearables. And to...

And Bernard -- sorry to interrupt.

No, okay.

On that on the acquisition appetite, I think in the past, maybe about a year ago, you talked about wanting to keep those acquisitions within or consistent with your organic growth framework in other words, not to detract from that. And so perhaps you could reinforce that or correct me if I'm wrong?

Yes. That's still the case. We don't want to go too far away from our core at this stage. So it's looking at products and our services that are pretty close to what we do right now. So we don't want to detract anything from the organic growth story that we're delivering on. That's first and foremost, our focus is to make sure we keep delivering on that.

And that would not prevent you from growing margin 100 basis points a year. Is that also fair to say or?

That's also fair to say at this point.

Okay. Okay. I think we've come up against the limit of time. So I appreciate the audience's attention and interest in West Pharma Services and Eric and Bernard your participation in the conference. If anyone has any questions, certainly, feel free to reach out to me, Dave Windley or to Quintin Lai, the company's VP of IR. Glad to field those questions. I appreciate again your participation and wish you all a great day. Thanks, guys.

Great, thank you.

Thank you, Dave.

Thanks.