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

My name is Casey Woodring in the Life Science, Tools Equity Research team here at JPMorgan. Welcome to our Annual Healthcare Conference. I'm pleased to introduce our next company, West Pharmaceuticals. Just a quick reminder for those listening before I hand it off to the management team here. If you'd like to ask a question during the Q&A portion of the presentation, there's an option to do so on the website. With that, I'll turn it over to Eric. Eric?

Great. Thank you, Casey, and thank you and JPMorgan for inviting us to this conference. Wish we were in person but in today's environment this surprise is a best alternative. I also want to welcome all the attendees to this presentation. Really thankful that you are part of today's call, and hopefully, we give more insights on who we are at West. To Slide 2, if you just hopefully have access to the slides, I'd just remind everyone around the safe harbor statement on Slide 2 and also in the presentation also can be found in our website for any further details. Let's start with Slide 3. It really is around purpose and the values of our organization. Obviously, we've been very thankful that the organization is really laser focused on improving patient lives. We work with our customers, the many drug companies, the biotech companies and able to get their drugs into the market and it's truly having a positive impact on numerous patients across the globe. When you think about who we are at West, for the last almost 100 years, this has been the driving force of what we are able to accomplish on a daily basis. The other area I want to support is the kind of what the value set West. There's really 3 areas that we're really focused on is passion for our customers, leadership and quality and the One West team, and that is the drivers of what we do each and every day to identify and solve the most complex problems for our customers and enable these medicines to get into the markets effectively. Into my Slide 4. What do we do at West? And for those that know us, we are one of the global leaders in the injectable medicine space. We really look at the business in really 3 different areas. You have your biocontainment and syringe components, administration and reconstitution and also in drug delivery and diagnostic devices. There's tremendous amount of abilities that we have within West globally to build support, a very high participation rate on all the molecules that are being delivered throughout the world. Turning to Slide 5. What's interesting, as I mentioned earlier, we're approaching 100 years mark for West, business was founded in 1923 by gentleman named Herman O. West and the core principle of trying to provide the highest quality product for containment and injectable medicines still is good part of the DNA of this organization. We've had a lot of changes in the last several years. And I would say the focus in the last few years has been around people, around structure and leveraging our assets more effectively. If you think about the changes that we've put in place for the last 3 years on a phenomenal company already, it's enabled us -- it's enabled West to be able to respond the way that we have responded in the last 24 months with when you think the double-digit growth in our base business and an increase in demand driven by the COVID vaccines. We're very proud that we have a very high participation rate in both areas, and we know that and we don't take that for granted. If you turn to Slide 6, there's a lot of things that we have accomplished in 2021. We will be coming out with our results in the second or third week of February. And also, we'll talk about guidance at that point in time. But what's really important of all these accolades and all the accomplishments, the team members across the globe have really delivered for the first 3 quarters a very solid performance. But we're almost proud of, there's really 2 elements that we started last year and this year that is safety of our team members in this environment that we're operating in and also ensure continuity of supply to all the drug companies across the globe. And I'm very proud of what we have accomplished in both areas, and we're not going to lose focus as we enter in 2022. And we want to continue to deliver on these commitments we've made for our customers and ultimately patients we jointly serve. There's a lot of accolades on here, but I would say that if you add it all up, it is really truly what West is all about driving the purpose and ensuring that we're able to impact patient lives. Turning to Slide 7. Think about our position is well solidified in the growing injectable medicine market. Think about the diversity of our platform, if you think about the markets, the products, geographies, this diversity provides a level of durability and sustainability as we think about our future. Particularly if you think about the highest growth areas within these markets, for example, biologics, our position continues to be very strong as we are continuously providing the new technologies and capabilities to service that area. From a geographic point of view, we're seeing all geographies growing quite nicely. What I'm quite pleased about is the more recent performance out of Asia Pacific and a traction we're gaining with the new approach we have in that particular geography. And the last thing I want to comment on is the continuation of our high-value product growth thesis. It continues to gain traction. And as you can see, we are now well over 50% of our revenues from an enterprise perspective is within the high-value products. So we're very comfortable with this platform, and it's well positioned for our future growth as we think about the next 5 or 10 years. Now if you turn over to Slide 8. Happy to do this. People ask a question to us frequently is what does market-led mean to you? And it's really when we think about it is letting drive in the market -- having the markets drive how we inform ourselves on products, solutions, new investments around R&D, around the global operations to ensure that we are driving solutions to our customers, and we're truly differentiated. This has been a significant shift in the mindset over the last several years and is paying off dividends. And again, not just on how we responded with the COVID vaccines, but also probably are able to respond with our base business and the continued growth in all areas of the portfolio. I'm going to turn our attention to Slide 9. This is kind of the landscape of our portfolio -- product portfolio. And what you'll notice is that as you continue to go up to the right, these obviously -- these products have a higher economic value for West, but obviously, more importantly, they have tremendous value creation for our customers and ultimately the patients. And as we think about investments, we think about capital deployment, we think about people, team members that we bring into the organization, our focus tends to be up to the right of this landscape, and we're starting to see significant penetration of adoption by our customers, which is really driving the performance that we are seeing here at West. Now let's talk a little bit about that performance. If you go to the next slide, the results from a top line perspective, it's been a very strong double-digit growth with our high-value products over the last 5 years, obviously, first 3 quarters of 2021, even stronger results, but it's a consistent opportunity that we have with high-value products to really drive the performance of the enterprise. And we believe that there's more runway ahead of this high-value product initiative, went from a component perspective to more of a system approach and West has the right to play as we interact directly with our customers across the globe. I want to turn your attention to the next slide, and this is really there's 2 elements to this one I talk about. One is the margin expansion spectrum, one is high-value product performance and runway. First, focus on our gross margin. You'll see in the middle section of this chart. And if you think back from 2016 to where we are now, it's approximately over 800, 850 basis points of expansion that has occurred for multiple reasons. One of the biggest lever of expansion has been the mix of high-value products. And if you think about -- if you look from the left to the right on the chart, you have the volume expressed high-value products, about 400 -- 4 percentage points increase over the last 5 years of volume expansion and as a percentage of the overall what we produce throughout West. And this year, we're approaching 45 -- I'm sorry, 2021, we approached 45 billion components produced here at West. Now that translates into revenue contribution from 45% in 2016 to about 58% for the first 3 quarters of 2021. And you can see just like the graph here how that benefits the gross margin and obviously ultimately impacting our customers in a positive way with ultimately better outcomes with patients. The big driver in the runway when we think about high-value products is in the marketplace around the biologics, and it continuously expands our high-value product portfolio. And again, not just on a component perspective, but also moving in towards systems. Do you want to go to Slide 12? All this translates into attractive diluted EPS of strong double-digit growth, and we do believe that this is obviously high-value product mix shift occurring. We also do believe that the global operations, leveraging the globalization of the operations, allowing us to leverage some of our assets more effectively and how we manage our costs across the enterprise. So I'm very pleased on our ended results from an EPS point of view. If we move to Slide 13. If you think about the market like journey that we're on, indicators of how well our market-led journey is around -- we look at the pipeline and our participation rate. We obviously continue to see very strong participation rate with -- by all the new approved biologics and also a very robust pipeline. And we also know that in our portfolio that tends to be towards FluroTec and NovaPure technologies. When you think about the -- in the past few years, the penetration rate in pharma and generics and small molecules continues to be stronger than it has historically. And I'm very pleased by that because it demonstrates the resiliency and the strength of having a market-led approach and we're truly identifying the uniqueness of each market and coming out with solutions as we continuously do to address those issues with our customers and obviously make them more successful at the end of the day. If we go to Slide 14, just on the operations side, as I mentioned a couple of years ago, we globalized the operations, and I'm very pleased with what the team has accomplished so far. And what I would argue is if that action was not taken 2 or 3 years ago, the real question is how would we've been able to respond in the last 1 or 2 years to support our customers, again, with the base business, but also with the COVID pandemic. And I would argue that we have more opportunities in this area as we continuously deploy more capital into automation. We continuously level load our operations through a network approach. These are all initiatives that are well underway that will continuously drive benefits as we move forward over the next several years. The supply chain has been very dynamic in the last few years for everybody. And I'm very proud on how the team has rose to the challenge to manage and mitigate risks, whether it's logistics, labor, whether it's around raw materials. The team has done a very good job to balance that and gives them a position that ultimately, at the end of the day, we need to continuously deliver for our customer and meet our commitments. If we go to Slide 5, this is an illustration of where we've been making the investments in the last 1 or 2 years, particularly around the COVID demand search. And we'll make it clear, these assets we're putting in place are assets that we have identified over the next few years to be brought into West to support the growth we're having in the high-value products, again, particularly in the biologics space. And if you think about the nimbleness and the capabilities for bringing in in-house today that is going to not only built to continuously match and be ahead of the curve on the demand that we're seeing with COVID-related products, but also in our base business. We're very excited to see how the team is implementing these investments that we've made over the last 2 years. It is incremental to what we historically have, but these are pointed towards products that are in the higher end of high-value price and have a demand forecast already set in the biologics space. And we're staying ahead of the curve, as they say, to make sure that we're able to support both the levers at this point in time. We're going to look to the next slide, please. I think -- a comment about ESG here at West. Like, I had been with West for about 6 -- 7 years, one thing I've learned is that this is already deep rooted into the DNA of this company. The organization has always had a very strong focus on the pillars that we've articulated here. I'm very pleased on the progress we made -- we've had. But more importantly, at the end of the day, it's built into the strategy of the organization versus the initiative that we set up. And I'm pleased on offering from that platform. And as we move forward, we'll be able to continuously challenge ourselves to make sure that we're operating a business model that has significant sustainability and durability for many futures ahead of us. In the last month or so, we recently updated our reporting to be in line with TFCD and also SASB, which you can find on our website. You're interested to see the information that we made public in our area of ESG. More to come, but I am very pleased to say the team in several years have been overdelivering on their commitments. And we look forward it continues to be really good citizens and the communities where we live, work and play across the globe, not just in our headquarters location but every facility, every plant across the globe as the same consistent mindset around ESG. So let me conclude. I believe I am within that time frame. We are operating from a position of strength. When I think about the strength of the base business, it continues to grow quite nicely for West. It's been double digits for the last couple of years. And we believe that our participation rate continues to be at or above the market at this point in time. We also -- we're very excited about the future. We think about delivering on our purpose, improving patient lives. One message I have to share with you is that as a traveler where I could travel to different sites, and you look at absenteeism level at a manufacturing plant, it's the lowest it's ever been during the pandemic because of the fact that our team members, 10,000 of our team members across the globe understand the purpose that they bring each and every day to our facilities. And they know that each and everyone is components of -- 45 billion components a year, each and every one of them has the patient name on it. That is the strength of this organization. And I'm really excited about what we built and what we're going in the future, and we have the right platform, we have the right markets that we're supporting. We have the right innovation and obviously, capital deployment and ability to look at ways to continuously expand our capabilities throughout West. So on that note, Casey, I'll turn it back to you and I'm going to bring in Bernard Birkett, our CFO, and we'll jointly answer any questions that anybody may have for today.

Thanks, Eric. That's a great overview. Maybe to get into the Q&A here. First one I have is that you guys have reported a strong third quarter with 29% growth, including mid-teens organic sales growth ex-COVID. Can you maybe talk about the drivers of that growth rate and the sustainability of that growth rate over time?

Yes, sure. If you think about the core obviously right now is on the biologics. It's the fastest-growing unit with and without COVID. And that really is when you think about the seeking the pipeline a number of years ago, particularly on NovaPure and FluroTec technologies, that is now becoming commercialized and uptake in the marketplace. So biologics is the #1. Our participation rate remains very high, which is the -- it was a clear indicator that our customers are looking at a platform approach, leveraging our high-value products. The other 2 areas within proprietary, I'm pleased with the performance over the last couple of years because of the focus that they have has been stronger than what I would say in the market. So you see double digits in pharma and also you see double digits in generics. Historically, what you would see is pharma around mid-single and generics about mid to high single. And I do believe that based on the data and based on what we hear from customers, it is, again, the win rates or the participation rate we have on new molecules, whether it's ANDAs or NMEs being approved. So the market approach is working, and it is giving better lens to these particular markets, and it's given us the confidence that we have the right formula to move forward with growth.

Yes -- we would expect, based on the order book and the demand that we're seeing there to continue to see strong growth in our business. And we typically guide in the past for long-term growth of 6% to 8% and 100 basis points operating margin improvement. Obviously, we've been overachieving on that over the last number of years. And at this point, we're not -- we're not changing that construct, but our objective purpose is to try and do better and serve the market whatever demand needs are there. You're on mute.

Sorry about that. Maybe on the COVID piece, you guided to $450 million in 2021 revenue there. Can you remind us what the sales guidance looks like maybe in the beginning of the year and how it was upwardly revised throughout the year? And any sort of color around 2022 for COVID, there's a lot of, I guess, variables there with Omicron, but maybe we can kind of start there.

Yes, I think when we look back to our guidance over the course of 2021 around call but it just shows how quickly things change, with responding to the pandemic in February, we were guiding about $260 million. And then in April, we changed to $345 million; in July, it was $430 million. And when we came out with our guidance in October call, we were looking at around guidance of $450 million net COVID impact for business. So it's forever changing. The demand has obviously been increasing on as we progress through the year. We're not at this point going to guide for 2022, but we'll do that on our call here in February. But again, as we said earlier, our order book is pretty strong. We have proved visibility into 2022 and into 2023, I mean we're also looking at to see how is response to COVID and the delivery methods. What impact will that have on our business is a potential upside for us there also.

Yes, we know you touched on the delivery methods. So I want to get into that. So there's been a discussion around the shift to new formats next themes such as fewer doses per vial and possibly moving to the single-dose prefilled syringes. Yes, the first question around that would be what are the implications here for your production?

Yes. It's actually created an increase in demand for West. As we think about our business model and we provide stoppers and seals for the vials and pointers for the prefilled syringes. And if you're going to go from 10 to 14 dose per vial to 1 to 3 as an example, and it's sort of the consistent patient population. And then you have the variables of how many boosters are going to be layered in over the next 6 to 12 months. That is a net positive for us. And if you move to a prefilled syringe, it's literally going to 1 unit per dose. And so -- and the economics for our plunger and the vial configuration is relatively the same. So we -- as customers migrate towards smaller doses per vial or to prefilled syringe, we're well positioned, investments that we're making and we've communicated that we made 4 tranches in the last 2 years towards -- to support the COVID demand and also base business demand that will help us to get ahead of these demand requests that our customers are having discussions with at this time. You're on mute again.

Sorry about that. I just had one comment on e-mail. So would you expand on your 100 bps of margin expansion. Is that a good starting point through 2022? Maybe talk a little bit towards...

We're not guiding for '22, obviously, on this call. But our long-term construct, as we've talked about in the past, and we're not changing at this point is 100 basis points plus. And so that's a reasonable starting point. But it's -- that's our long-term construct. We haven't changed that.

Got it. A follow-up to that would be, would you agree [indiscernible] at this morning, I think, was talking around the vaccine business would be -- would double in 2022 over 2021. That's in terms of doses. Would you say that's sort of in line with how you're thinking or not?

Sorry, we can't comment at this point in time. We -- obviously, with everything you discussed and asked and what we've commented on about different dose configurations, the current demand in the marketplace, more geographies to these -- these are all net positive, we're not going to mention that at this point of time.

Okay. Maybe shifting over to the high-value products. On prior calls, you've talked about FluroTec and NovaPure as drivers of growth. Maybe to start, what are the reasons that you're seeing such strong uptake for both of those products?

When we think about what's fundamental of those products, it's the barrier code that -- through our partnership with Daikyo in Japan and then some 40-plus [ homes ] approaching 30-year relationship with phenomenal group of talented individuals over in Japan. There's fluoropolymer coated components as the industry standard for injectable drugs and that are sensitive to extractables and leachables, which are including large molecule and biologic drugs. So fundamentally, that's what's driving the adoption, and it's been considered some of the standards in the industry, frankly, and particularly in the biologics space. So therefore, as we are solving customers' complex issues, we're looking at the NovaPure, looking at the FluroTec as solutions for our customers. But it's really driven by the technology in the manufacturing process that is between Daikyo and West.

Got you. How much additional capacity that you installed in 2021 would you expect to install in 2022? How much is that dedicated to FluroTec and NovaPure? And maybe just more broadly talk about the investments you're making in both of those products, I guess, from a capacity standpoint as well as sales and marketing?

Yes. So if you think about the capital that we're deploying above and beyond what we typically have done historically, it is really around the FluroTec and NovaPure technology. And what's really -- what I'm very pleased about is as we think about investments is that the global operations truly has rightsized, I would say, the facilities and infrastructure so that as we put these investments in majority, not all, majority of it is equipment or processes that as soon as we are able to turn these on, we're able to fill them and utilize for the demand that we currently have in our possession today. And so what you'll find is that we're going to a less land and buildings acquisitions and [indiscernible] fast return and will respond more effectively. But it's -- we're learning capital that was deployed in 2021. And throughout 2022, we have additional capital that we've committed that's already coming in. It's going through the process for validation, and we'll see that again in 2023 and a little beyond based on the forecasts that we have, the lens that we have through our confirmed order book as well into 2023, the discussions we're having with our customers, base customers, but also the COVID customers. We're pretty comfortable that we're making the right decisions over the right time to get into our facilities to be able to support the demand that we have in our possession.

Got you. I wanted to shift towards inflation and the labor market. That's been -- I have [ the line ] here for all of our companies frequently here recently. So maybe can you comment on the impacts you saw in 2021, specifically from inflation and the tight labor market? And what do you expect here in the near term?

Yes. From an inflation perspective, we've seen cost increases come through with 2020 and more so in 2021. We're fortunate not to be in a position to be able to pass many of those costs on to our customers. And that's through agreements that we have in place. Now there is a lag between when we see the cost increase initially, and then when we're able to pass on, it's typically about 1 to 2 quarters. And so we can carry it for 1 or 2 quarters. It's not an only material item for us. But again, we have that ability. And also, we did see increases in logistics costs. Again, we were able to pass much of that on to customers and through negotiation and agreements that we have in place. On the tight labor markets, we've seen that specifically within the US. In Europe and Asia, we had some impact and not to the extent we've seen here in the US. But with the systems that we have in place, with the HR structures that we've put in place, we've been able to hire the correct number of people that we need in many of our facilities. And for most of the cases, we are able to retain those people as well. So we're -- I think it's been a challenge, but we've been quite successful at getting the numbers that we need. On wage inflation and payroll inflation, again, we have seen some -- we've been able to respond to market. And what we're seeing then we're able to offset that with increased efficiencies within our facilities and many of these facilities were also around 24/7. So we're getting better absorption. So from a cost perspective, we've been able to manage it quite well and throughout 2020 and 2021.

Got you. And maybe a follow-up there on supply chain. Are you seeing any sort of headwinds there in terms of securing supply in the...

So yes, absolutely correct. So over -- when you think about supply chain, 2 things. One on the logistics side, we found ourselves need to partner with certain firms that fly materials across the globe versus ocean freight as an example. So there's additional cost associated with that, but we want to make sure that we are not creating any delays to our customers. But from a supply, from a raw material perspective, there are certain areas where we make sure that we have secured the supply by increasing the amount of safety stock that it will have in a couple of locations, particularly when you start thinking about materials that we work with Daikyo on and there's quite a distance between our plants in Tokyo. So the team has done a really good job. But it's a constant challenge. The team -- when we think about what they have gone through in the last few years, the work they did prior to that about identifying secondary and tertiary supply, qualify and validating and making sure that it's equivalent, that work is paying off because at this point in time, there may be a delay in one area where we'll pick it up in a different area. And so, so far, we've been able to manage through this. But it changes every day. And -- but the way that we structured it, we were looking at it from a global perspective and the global team is in place, we will manage through this quite nicely. There's new costs associated with that, but the...

There's cost but most important thing is we're able to service our customers, but it's very -- like I said, it is a challenge, it's forever changing, but we're proactively managing a lot of these issues would identify the key components and materials that we need and the supply chain of the networks. And again, that goes back to pre-2020, the work that we've done really making sure that we have the structures in place to make sure that we didn't run out and -- but again, it's something that we have to work on every day.

Got you. One on CapEx here and a follow-up to the capacity question. So in addition to increasing CapEx for capacity, could you describe some other areas that you're looking to invest both organically and maybe inorganically?

Yes, I'll start. Absolutely. So from an organic point of view, we are continuously investing. And we're doing a very methodical approach to get into areas that we know that the products that we're going to produce will support more than just one particular area of the business. So as you think about variability and total demand, but obviously, in biologics is this consistency on the portfolio, which is very beneficial as you think about these investments, and we're going to put these investments in. So the number one priority is around capital deployment, around organic growth, around equipment and capabilities internally includes such as automation and improving our efficiencies and yield, throughput and quality for our customers, which I'm quite excited about because it is supporting, again, the high-value products. Digitization of our organization is another area of investment. We made tremendous leaps -- steps in the last 2 to 3 years. That's given us a platform now to all make decisions faster. Information is readily available and allows our facilities to be more efficient. So these are more of the organic type of investments. Do you want to touch on inorganic?

Yes, on the inorganic side, this has become more of a focus for us. We're actually building the -- increasing the level of competency and capabilities we have within the organization to be able to go and take on more acquisitions and we become more active in that space. We started building out a corporate development team, on top of what we already have. We started that in September of 2021. And that's underway. So there are a number of different areas we're looking at to see both from brand new technologies, how early we get involved in those, what changes are happening in the market. As Eric mentioned earlier, looking at system approaches, are there different technologies that we bring to our customers and different solutions, more comprehensive solutions and also looking at the drug delivery and wearable space. There are areas where we can expand on there. So there are a number of different and focuses for us and the level of activity will increase here in the near future.

Got you. One just came in on e-mail. So R&D spend is just $50 million, I think that's annually. Why is that an appropriate level of R&D spend for you guys?

Yes. We are consistently reviewing that, and we're looking at ways to where can we redeploy. So for example, we have realigned our R&D efforts in the last year, really at the end of 2020 into early 2021. And we focused on how do we go harder on the [indiscernible] than we historically have done in the past, is mostly around development. Doesn't mean that development has lost support. It's actually increased this year with the number of development agreements that we have with customers both on the component side, but also on the device side. So we're pretty excited about the prospects of what that will -- what will come out of that effort with our drug companies. So we're constantly looking at investments in this area. We've made considerable investments around people. around talent to get on the R of R&D. And we'll see that trend play out in 2022 and 2023 as we go forward.

Got you. Maybe in the last few minutes here, going back to the inorganic piece, can you talk to maybe are there any gaps in the portfolio that are sort of notable that maybe you'd look to add inorganically there?

I think the way to describe it is that it's interesting because of our position in the market because the trust that we built with our customers is being brought into the discussion about how do we solve these complex problems versus from a component perspective but from a system perspective. And we're engaged with more of those types of conversations in the last couple of years than we've ever had before. And we see this as kind of the shift that's occurring, and we're very well positioned to address that. So it would be parts of the portfolio where we just simply don't have those types of products and/or services that are very close or adjacent to what we do today. Yes, we have a very strong elastomeric and seal manufacturing capabilities. We have very strong administrative systems, capabilities -- device capabilities, but there are certain areas within the whole containment and delivery devices that need to be as opportunities -- strategic opportunities still to reinforce our portfolio and moving to more of a complete solution or system approach to our customers.

Got you. Maybe in the last couple of minutes, I didn't fit this in when we were talking about the high-value products later. But I'm wondering, impact on margins given the higher pricing that you guys see on those products. Can you just maybe talk about this dynamic and how that sort of you're expecting that to play out over the next few years?

Yes. So you can see the impact that the high-value products has on margin over the last number of years as the conversion to high-value products or the adoption of high-value products [Audio Gap] has taken place or margin has expanded well beyond 100 basis points, volume percentage to really a large revenue and margin expansion opportunity. And that has been reflected in the results that Eric outlined earlier in the presentation. And again, a lot of that is driven through the Biologics segment. And that's what we've seen Biologics move from 22% overall revenues to close to 40% for the first 3 quarters of 2021. And again, that's the most profitable part of our business. So it's a very powerful mix shift.

Got you. Okay. Well, it looks like we're bumping up to the end of our session here. I want to thank the team from West. That was a great overview, and enjoy the rest of the conference.

Thank you, Casey.