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

Good morning, everybody, I'm Jacob Johnson, Life Science Tools and diagnostics analyst here at Stephens. Really pleased to be joined by Quintin Lai, Head of Corporate Development and Investor Relations at West. Quintin, thanks for joining us today. I'll turn it over to you for any introductory comments you want to make, and then we'll launch into Q&A.

Well, Jacob, first on behalf of what we want to thank Stephens for hosting us here at the conference. It's great to be in person here and really impressed with how Stephens has set up the conference, and very much appreciate that.

Thank you for, Quintin. I know we need to talk COVID at some point, but I don't want to start there even with this variant. So let's talk non-COVID and the broader trends you're seeing because you're posting really impressive growth in biologics even if we back out the COVID benefit. So what's going on in the biologics market that you're benefiting from right now?

So what we're seeing right now in the -- what we call our base non-COVID business is a continuation of secular growth trends. Injectable drugs continue to grow as a category, and within that category, biologics, large molecules are the ones that are driving the new growth. And of many of those biologic and large molecule drugs that are coming out, many of those companies are selecting our highest level high-value product components like NovaPure or FluroTec. And so that volume increase that we're getting is also coming with our premium products.

Yes. Okay. In terms of just, I guess, doubling down on that question, just is some of this a benefit from in that COVID world a year ago? You didn't maybe have as much activity on the biologics side, though it didn't seem to slow down too terribly much ex-COVID. I guess there's some kind of post-COVID kind of snapback that you've seen this year?

There might be a little bit of post COVID. But that's probably more on the legacy side. So things like -- if we remember a year ago, pre-vaccine Q3, elective surgeries were down, dental procedures were down, animal health was down. And so we saw -- seeing we're a little bit of a pickup there, but that really doesn't explain the growth in the biologics business. I mean, there, I think that when you look at that category, those are drugs that are absolutely necessary, whether they be cancer or rheumatoid arthritis or anything in that -- in those areas. And what we're seeing are patients still getting their drugs and there's continued traction, especially in the drugs that have been launched over the last 5 years.

Got it. So let's dig in on the high-value products. Over half -- well over half of your revenues. But from a volume perspective, where do you stand in terms of high-value product adoption versus standard components?

So if you look at our proprietary business, we're sitting somewhere around -- somewhere below 80%, maybe around 78% or so of our volume is standard. And then is a high-value product. And where we were 5 years ago, it was sitting probably more like 84%, 85% and 15%, 16%.

So call it, 1% a year, is that a good kind of proxy?

It kind of works that math out, yes.

Yes. Got it. And just maybe remind us kind of pricing generally in terms of standard versus high-value products and why this is -- that shift is so powerful?

So standard product it could be, if we translate it per piece, maybe $0.01 to $0.02 a piece. And then as you move up the high value chain, you can go to washed. And it could be maybe $0.04 to $0.05 a piece to sterilized to $0.07 to $0.08 a piece and then coated and then envisioned inspected. And then if it gets all the way to a combination of all of our high-value products and offerings and quality by design to NovaPure, then you could be looking at $0.75 to $1 a piece, maybe even more.

Got you. I guess as we think about this, the shift to high-value products that is going on right now, what is driving customers to FluroTec and NovaPure? Is it something about these new outside of biologics and the growth there? But is it something about the new molecules that are coming to market that people are looking for kind of the highest end stuff? Is your sales team just getting better explain the value proposition? Are people just platforming these? Like what's causing that shift?

So for large molecules for protein-based antibody-based drugs, there you're looking at bio compatibility. And there, you're talking about compounds that are very sensitive to the package, sensitive to potential compounds that could be extracted or leached from the package. And because of that sensitivity, there is a need for some type of barrier coating, which FluroTec -- which we offer with our partner, Daikyo in Japan, is the industry standard. And so again, it starts with compatibility. Then when you start to think about in terms of trying to get the best package for your precious asset. If you're the drug company, you're trying to get the highest yield, high-risk reproducibility, then you start to gravitate to our higher offerings where we're doing quality by design. We're doing things in clean -- we're manufacturing and clean room environments. We're doing vision inspection. We're doing tolerance checks at every step along the way to provide the best yield possible and the best outcomes possible. And so these new companies that are -- or the companies that are have pipeline drugs that are coming out, a lot of them are drugs that are -- have APIs that are very expensive and really hard for them to throw away and reprocess if there's any type of contamination. And so they're doing their analysis and saying, "Hey, we would need the NovaPure class drug -- component."

Got it. And then NovaPure is the highest value product do you have today. How much more innovation can you drive in kind of containment solutions? And could you launch something that's even beyond NovaPure at some point?

We've got a really robust R&D platform that is looking at a variety of things. And really, it is trying to anticipate where drugs are going, the types of drugs that are being developed as well as where are the regulators going because the regulators continue to raise the bar in the U.S., in the EU, in the U.K. and in China. And so with all of those, there are opportunities to continue to raise the bar. And so nothing to announce here, but there's always -- we anticipate there will be future product offerings and future iterations beyond just where we are today with NovaPure.

Got it. That's helpful. And then I think the other piece of proprietary products that maybe we don't talk about as much is delivery devices, that would seem to be, to me, to be a sizable opportunity just because you have kind of health care moving closer to the patient probably. So maybe just talk about your offerings in that portfolio? And then how much of a strategic focus are those delivery devices?

So delivery devices, I think that what we've seen over the last decade is that drug companies are looking to improve access and uptake and repeatability of use by their patients, and trying to find a format to make it easier to -- for customer -- or for patients to do self-administration, which then avoids the need to have to go into the hospital, to go into an infusion center. That has been a trend that's been going on for a while. And we participate, first of all, on the primary containment side. So we make plungers, we make various components that go into a lot of devices like prefilled syringes, like auto injectors. We participate in our own business because we provide an alternative to glass, Crystal Zenith. And in there, this is where we make a component, a container that is -- has superiority to glass in certain areas. And so for compounds that are sensitive to certain frailties of glass, they will opt to Crystal Zenith, and we're seeing strong uptake in syringes. And so we've talked about that on prior conference calls about the fact that we're expanding capacity there. We make -- on the auto-injector side, we participate both in our contract manufacturing where the customers have the IP, and we will make that product on behalf of the customer. And then, of course, inside there, there's going to be a container with most likely a West rubber -- elastomer component. We also make a hand-powered auto-injector called SelfDose. And so there -- for those that are looking for a product that is differentiated from the spring-based spring-loaded auto-injector, we make that. And then West has been a pioneer in the wearable side, where you're looking at something that is beyond the 1 mL or 2 mL auto-injector, so something 3 to on upward volume, where you're looking to have a longer delivery cycle. And there, we have our SmartDose platform.

Yes. I mean where are we in that shift, do you think, to being closer to the patient and more kind of easy to administer therapies?

It's still really early days. It is still really early that we're starting to see uptake on the Crystal Zenith side. The interest level on our wearable side continues to grow. And I think that one of the things that has happened here during the pandemic is just an acknowledgment in the industry and the drug companies, how important it is to give those options for patients to self-administer so that they don't have to go into infusion centers. They don't have to go into the doctor to get it. That said, I mean, we -- overall, this industry continues to be a slow cycle, a long cycle process. So still pretty bright future, but it's very early.

Got it. So we've talked about a lot of growth drivers, but COVID is not insignificant either. So maybe just remind everybody kind of the 2021 COVID benefit that you've guided to? And any initial thoughts as we look into 2022?

So on our Q3 call, what we expected for the full year is about $450 million of COVID-19-related sales. Most of that is vaccine-related. The landscape and continues to shift almost on a weekly basis. Based on the conversations we're having with our customers, based on the order book that we had, what we said on the call is that as we look out to next year, we don't see a decline in the business. And we'll update guidance on our Q4 call.

And why is that? Sorry, international markets -- or why don't you see a decline?

So the question is why don't we see a decline? Again, I think that we're still relatively -- I mean even though there are some countries that have high accessibility. There are still some countries that still don't. And that, coupled with boosters that are now being -- that were coming out is the reason why we said that. And again, it's based on the conversations we're having with our customers. But as a reminder, all of that was pre-Omicron.

Yes. Well, I have an Omicron question, but let me maybe ask that question a little bit different way. Is there anything as you look into 2022, revenues are going to be up. Is there anything different about the composition of those revenues where they're coming from?

Again, we're not commenting on 2022. Nice try, Jacob. Again, what we were saying is that just qualitatively that just based on what we saw, the question that we were addressing at the time was, is there going to be a decline? We don't think so right now. And we'll sharpen the pencil when we give guidance.

Yes. For the record, you brought up Omicron. So now I'm allowed to ask about it. Any thoughts on the potential impact from Omicron?

Still too early. It's still too early. And again, I think that this is where -- it's really critical that our teams continue to have that high level of dialogue with our customers. That's something that we implemented early in the pandemic, at the start in 2022, and that has continued on. And really that is -- we think that is critical because -- as we said, the landscape continues to change on a weekly basis. And our job is to make sure that we have we -- we are prepared for whatever comes because what we want to make sure is that there is good supply out there in the market.

Got it. One other question here that I think has been talked about ad nauseam, but we think we have to address it. Just the smaller -- on this potential shift to smaller dose profile configurations or maybe prefilled syringes. What are you hearing about customers around potential changes to how these vaccines are delivered?

So our 2021 guidance assumes no shift in format. Again, I think that as we're looking at it, I mean, right now in the near term, there's still so many areas that need vaccine. And so everybody is moving as fast as they can to get the vaccine out there. That said, we have had conversations with customers and we have -- there are scenarios where it could go to fewer doses per vial. And in that scenario, again, all things being equal with the same number of doses, it will require us to produce more. But again, that's all things being equal.

Yes. I mean in terms of -- I'll ask 1 more here and then I promise will move on from it. But do you think we go to first fewer doses per vial before going to prefilled syringes? Or maybe just talk about like why people want to move in that direction? Maybe that's better way to ask about it.

Yes. In terms of timing, when and if that really -- that question is best for the vaccine manufacturers. Based on what you look at in terms of things like let's take a more common vaccine like the flu vaccine. If you take a look at the formats that the flu vaccine comes into, it's fewer doses per vial, and in many cases, is a prefilled syringe. And there's a lot of ease and use for that. And if you think about how flu vaccine is disseminated today, you can go to your doctor's office, you can go to a pharmacy, you can go to the clinics. -- whereas today on COVID-19, a lot of it's going to be done in some of these more mass vaccination clinics as well as pharmacies. And if you talk to some pharmacies, it really does slow down the workflow to have to work on these multi-dose vials and have to fill them. And their stories at the end of the day of some doses not being used because you had to pop a multi-dose vial, and it turns out that there weren't enough arms to put them in.

Yes. Got it. On that note, let's talk about capacity. You've announced, what to bring up to 4 capacity additions now. Can you just walk through, I mean, kind of really strong demand backdrop. So what are you having to do to meet that demand?

Well, I think that let us kind of roll back to early in the pandemic, Q1 March time frame, when there was awareness that this could be an issue in 2020. We started to say, okay, in the event that this happens, we better start to increase capacity because it could be a therapeutic, maybe a vaccine. As -- and that was really kind of the first phase of just building ahead of the curve because you need to be ready in that event. As 2020 went on and some of the vaccine companies started to have success and through the communication, again, communication with our customers, we said, okay, it makes sense to get that second phase going because we need to be ready. And so we've been layering in that extra capacity. And the key thing for that extra capacity is that it was in our existing sites, in our global network. And so it's the U.S., it was in Europe, it was in Asia. And so the fact that we were able to flex that network and increase capacity with bringing mainly equipment in and getting that equipment ordered, delivered and validated, and we've been able to layer that through. The question 2020 was at the time was, okay, what if COVID goes away, right? That was the talk in -- remember, in 2020. What if it goes away? Or what if a vaccine is so effective that you don't need to get revaccinated. In that scenario, it was a pull forward for us for that capacity because the components we're making for COVID-19 are the same components we're using for some of the drugs that are being used today. So there was -- so we said, okay, in that regard, we'll grow into that capacity then. And so then 2021 comes, and then we start to see Delta way, the Delta, we see need for boosters. We're running at really high capacity utilization today, and we've got a growing base business, which is what we started this conversation with. Well, now the question is, okay, how do we get -- how do we get extra capacity for that base business as well as the COVID-19 business we have? So then we started to say, okay, we need another phase and so Phase III. And then as we continue to have that dialogue, then in October, we announced Phase IV. And so that is our commitment is that we're always taking a look to try to say, okay, how do you stay on top of it. And because we have a responsibility not only to stay ahead of whatever happens on COVID-19 and the demand that might come from there. But we've also got to do it for our base business because those drugs are also life-critical drugs.

Yes. So you mentioned in 2020, you were saying, well, what happens if COVID goes away? These were already planned and then you did 3 and 4. So in 2021, what happens is the 3 and 4 if COVID goes away?

Well, again, I mean, I think that we will grow into it. I mean it is -- the stuff we're bringing in it's not greenfield capacity. It's expansion of our centers of excellence. And the equipment, the processes that we're bringing in are the same that we use for our biologics business.

Yes. Just remind us what products this capacity is largely supporting?

So what we've said is that a lot of the capacity is for NovaPure, HVP level and both stoppers and plungers.

Stoppers, yes. And then going back to your comment about where and how you're building this capacity. Maybe just -- I think it would be helpful maybe to go back to like the journey you're on a couple of years ago, kind of consolidating sites and talk about your footprint today and why it's kind of more cost effective, for lack of a better word, the way you're adding capacity?

So one of the things that we did and really going back, I'd say, 5 years ago, is that we made an effort to globalize our franchise. We were operating more on a regional basis. what we did -- we went through that process to bring everything under a global network, to raise all of our regions to a global standard, to raise all of our supply chain from regional to global standard. And the thought process there was it was going to add flexibility. It was also going to improve the types of products we had, the -- reduce the variance that we had, it was going to be produce a better, more uniform product and allow our customers that if they wanted to be able to source from various places within our network to be able to give them that opportunity. Then now you fast forward to 2020 and 2021 when the pandemic hit, had we not made those processes, I think that we would have been a little bit wrong footed. But as it is -- as it was because we had a more robust supply chain, because we had the global network, the concept in, we were able to absorb some of the hits that came and continue to come. I mean so supply chain has not been overall an issue. But if you look under the hood, we're dealing with issues all the time, and whether they be logistics or certain materials, but because our team are working so well, and they're really, really busy, but they've done an excellent job of staying on top of it to make sure that all the products get out there. And we have as minimal impact to the customers as possible. And so a lot of the changes that were made 5 years ago really have been seeds the for the success that we're having today.

I mean how much more capacity can you add within your existing footprint? And maybe it's just adding it within existing campuses? Or would you ever need to add another location?

Right now, what we're doing is that we are adding in existing. There are a couple of sites where we can do building expansions. For example, Waterford, Ireland, which is our latest site that we have. I mean the design was such that we could build off of the spine of the building and go radially. And so there's plenty of opportunity to continue to do that. Kinston, North Carolina, another prime example of another centers of excellence where we're able to build off of that spine. So it's not that there won't be any building. It's just -- it won't be a new site. It will be building expansions off of the existing.

I mean, in terms of your geographic reach, would you ever need a facility somewhere else in a certain country or something? Or do you have pretty good reach with where you're today?

We have really good reach. So if you look at it right now for HVP, we have 2 sites in the U.S. We have 2 sites in Europe. We have 1 site in Asia. And then for standard product, we have sites throughout U.S., Europe, Asia and South America. And so we feel really good about our global network.

Got you. Maybe while we're talking about the global network and the globe. Just on China, I think that's becoming more important region for everybody in kind of the bioprocessing industry broadly. Can you just talk about how it's a unique market? And so how West is competing there I guess?

You're absolutely right. I mean it's a market that we have a great presence in. We have a long history in that area. We participate in the premium parts of that market. So for multinationals that are moving into that region, we're selling products that the multinationals use in other areas. So they don't switch, they just continue to use those products. For the companies within Asia, including China, that are looking to export, they're going to be held to the same standards that the EMA and the FDA are going to put on. So again, high-value products there. And then within the country, we're seeing ever-increasing regulatory standards so that the more sensitive drugs are using our higher-value offerings.

And then just something going back to capacity, can you just talk about where the lead times stand for you today with customers and maybe how that's trended throughout the pandemic?

So lead times are something that they have increased some. And there -- because we're running at really high capacity. But what we're doing is we're using communication and really talking with our customers to say, look, the more that they can communicate with us on when they need it, we will make sure that we get it into the production schedule. We're not a just-in-time business. We are made to order. And so that's why when we take a look at our order book, not only is there just overall increased demand, but then there's also increased visibility for demand out -- several quarters out. And so again, what it says to us is that our customers are also realizing they need to do better scheduling with us. And so that's how we're trying to address that.

And just one other one kind of related. I think everybody, again, in broader bioprocessing, is wondering to what extent our customers stocking inventory. I'm guessing companies are doing it, especially in this environment. Can you just talk about any anecdotes of kind of investor stocking? And do you think that's been a benefit to some of the growth this year?

I think it's probably the other way around. We've been very direct expressing to our customers. Please do not stock because right now, we are trying to prioritize the COVID-19 effort. And so to the to the best of how we look at it, we do not see significant stocking in the system. More -- what we're doing now is really just talking with our customers and saying, help us out, if there's a launch that you've got, or if there's a new plant that you're bringing online and there's extra supply you need for that, then work with us and we'll get you into the schedule. But that's one of the issues you have when you're running at such high capacity with very little uplift, you've got to manage these things carefully.

And lead times are extended with your customers and vice versa on your suppliers?

So the question is, is that are lead times for our suppliers, have they...

And to your customers that might encourage them to stock.

Well, look, I mean, I think that the pandemic has caused lead time expansion throughout the whole thing. But that's where having a robust supply chain organization and making sure that we have our own safety stock. So we're dealing with that in terms of the lead times they have to get to us. And then we use that because we have a robust kind of supply chain and inventory management system that hopefully we don't have it push forward too much to our customers. Thank you for the question.

Anybody else have a question? Maybe moving on to contract manufacturing. Can you just talk about the growth in 2021, I think coming off a pretty strong 2020, how we should think about the long-term growth of that segment and maybe the key growth drivers of it?

So when you look at contract manufacturing, this is where we manufacture on behalf of the customer that has IP. And typically, we're one of several suppliers that go to those customers. It is a business that really requires very high capacity utilization. And when you bring on new projects, usually there's a CapEx component with that. And over the last year, we have prioritized our CapEx more on the proprietary side because of a lot of the issues that we've been talking about here about the growing base business in COVID-19. So because of, we haven't put as much CapEx into it as this year as we've had in prior years, you see a little bit slower growth. We think longer term, it's a mid-single-digit business for us. It's a very good cash flowing business that doesn't require a whole lot of SG&A and R&D compared to our proprietary business.

Maybe 1 follow-up. Can you just remind us of the synergies between these segments?

So if you look at the customers that we have on the contract manufacturing side. Over the last 10 years, we've really paired back consumer products. We've focused mostly on health care, mostly on areas that either are involved with injection or complement injection like continuous glucose monitors for diabetes, which has -- which obviously has an injection component. Many of the customers that we have are customers of our proprietary business. And so the products that we manufacture very often may have a container inside of it that has an elastomer. And so there are some customer synergies we have there. And so -- and then from a technology synergy, the contract manufacturing side is highly automated. And we're bringing a lot of that know-how over into our proprietary business.

Then on margins, I mean, the revenue figures have been really good, but I think the margins have been really, really impressive over the last 2 years. Obviously, some of that's been the benefit from COVID being kind of high-value product sales, but you've also had some internal initiatives over the last several years, too. So as we think about margins from here after you've accomplished that, how much more opportunity is there for operational improvement? And then just remind us how much the opportunity is with the high-value product mix shift to margins?

So, okay. So if we just put COVID aside and you take a look at our growth construct, high-value product sales are growing faster than our standard business. They come in at a more favorable margins for us. And so there is a mix shift that helps power gross margins. Then on top of that, we are always -- we have that culture of continuous improvement and always improving the operational structure and looking for efficiencies. That also helps year-on-year margin expansion. So those efficiencies help offset any type of increases that we have in terms of people and personnel and salary increases. And then one of the things that we've talked -- that I just mentioned earlier is that on our proprietary business, a lot of the process that we have are legacy processes. Adding automation will also further increase not just the efficiency side, but we also believe it's also going to create a higher level of quality, lower variance. And so there's some benefits for the products and the customers as well as for West, and we're still very early in, at least on that.

Where do you stand on that? Like how many facilities have you rolled that out to?

Yes. I mean we haven't -- we have various sites, but it is still really early. This is an industry that -- change is not something that happens overnight because you're working on processes that are already spec-ed into the customers' drug filings. And so when you do any type of changes, they're going to have to open up their filings and have to adjust for that. So it is something that's going to get layered in year-on-year. And so as we look at it from here and over the next few years, we see quite a bit of opportunity to continue to implement these operational changes.

Got it. You've launched, I think, some new digital tools recently. I think Delta Cube being one of them. Can you just talk about the value proposition of that for customers? And then is this something that's been driven by like the COVID world we're living in or something else?

So something like Delta Cube, that's not being driven by the COVID. That's really being driven by the standards that the regulators and the various industry groups are pushing on to the industry. What they're looking for is better reproducibility, fewer catastrophic errors. And so they're coming at it and looking and saying, okay, we can see the components having an issue and all the component suppliers know what their components are. But we're looking at it from a system point of view because you've got to put these components together with each other. And because of our leadership and elastomers, very often, we'll get inquiries from our customers saying, okay, West, can you help us understand how this -- how your component works with this glass or this glass or this glass or are these other systems or this other fill-finish system. And so after getting all these inquiries, our team came together with Delta Cube to come up with a way to characterize, in this case, a vial capping system. And it is innovative in the industry. It is something that provides a system look at how vials are put together. And we're really proud of that we're able to launch it. And we're getting really nice uptake in terms of people looking and using that tool.

Got it. Something that I think Eric mentioned, it's probably been a couple of quarters now. But just -- yes, the opportunity in cell and gene therapy, and I think they clearly need your products and probably the highest of the high-value products. But can you just talk about the opportunity in that industry, if there's anything incremental you could maybe be doing to capture more benefit from that market? And maybe just broader thoughts?

Again, it's one of those things where because we have a lot of interaction with our customers and they're bringing these -- the more they know about what West brings, and how we help on the final packaging, these customers are starting to ask, say, well, if we're going to end with this type of product, maybe be should be working it in earlier in the process. And so those are the conversations that we're having with some of the cell and gene therapy companies. And it's a work in progress. Because we already have a high participation rate now on the ones that are commercial. They are not that many that are commercial. But in terms of the ones that are in the pipeline, there's a lot. And the amount of inquiries we're getting are increasing. And that's why we said there's an opportunity here. And we're having those conversations as we speak.

Got it. And then maybe the last one for me. You're generating a bunch of cash right now. I think you've mentioned that after, I think, years of a lot of organic focus that M&A is something you're contemplating right now. So can you just talk about what kind of capabilities you might be interested in adding and what the pipeline looks like?

So first, let's start with kind of our base business. We have -- we believe that we're in a market with really strong secular growth trends. We think that we've got a lot -- quite a bit of runway to our HVP growth and margin expansion. And so our first and foremost use of capital is continuing to invest to -- in that organic growth story. Any -- we're always looking for technologies and opportunities that can complement what we have that can leverage the strength of what we have and that matches up with the culture that we have of quality, science and scale. And so -- but anything that we would contemplate has to not detract from that base business. And that said, we are bulking up our corporate development program. We brought in a new Vice President of Corporate Development. And we're looking forward to talking more about it in the future.

Perfect. Well, Quintin, on behalf of Stephens and myself, thank you very much for making the trip to Nashville. Great to see you. Thanks, everybody else, for joining.

Thank you, Jacob.