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

So thanks for -- welcome to the UBS 2023 conference here. I'm John Sourbeer, UBS's life science analyst. Happy to host the fireside today with West Pharmaceuticals. Joining me is CEO and President, Eric Green; and VP of Investor Relations, Quintin Lai. Thanks for attending here.

Yes, John, thanks for having us. It's been a really good day here at UBS. So thank you.

Great. So maybe start off here, high-level question. I know you guys reported earnings a couple of weeks ago, but on the demand environment, the company continues to see strong demand really across this proprietary product segment and the broader portfolio despite macro headwinds seen by peers and others within biologics or [ larger ] biopharma life science tools. So I guess when you look at that demand, how much of this is GLP-1s versus traditional biologics, mAbs, and can you just talk about how sustainable is the current demand environment? Maybe I'll pause there.

Yes. Thanks, John. I think when we look at the growth of the business, it's really -- kind of break it out in 2 components. One, let's take COVID out of the picture. As you know, we had significant participation with -- during the pandemic. But the core business itself, the base business, has been growing double digits since early 2019, consistently on a quarterly basis. And it's really driven by a couple of key areas. Number 1 is from the biologics. That continues to be the fastest area of growth for West, and our participation rate remains very high in that particular space. That also includes biosimilars. And we're also seeing good growth in -- out of our pharma and our generics business. In fact, generic business has been growing quite faster than what we'd say about the long-term construct. So the business has been growing strong double digits for quite a while. However, when we think about high single-digit growth for West, we're really thinking about long-term growth algorithm of 7% to 9%. And the way to break that down is to think about double-digit growth for biologics; generics, we believe it's mid- to high single digits for West; and then pharma, which is innovative molecule sector, is low to medium. And then our contract manufacturing business, which is about 17% or 18% of our business is growing, we believe, long-term construct is mid- to high single digits. So when you roll that together, it gets you that 7% to 9% long-term construct, which we have been exceeding over the last few years, which is positive.

Great. And maybe just because you touched on it, I'll ask this great question, maybe piece -- time to ask this, but the contract manufacturing, you did, I think, maybe 2 quarters ago, increase the construct there. But even with that being increased, you're still thinking 7% to 9% long-term is the sustainable growth for the business?

Yes. For overall enterprise -- just a few years ago, contract manufacturing was a larger portion of our overall enterprise, and that's come down to about 17% to 18%. So we do believe mid- to high single-digit growth is what we'll see with contract manufacturing more long term. I realize this year, we're good, solid double-digit growth. That's due to layering capital we put in last year that is now up and running and commercialized today. So the long-term mid- to high single is our corridor with contract manufacturing.

Great. And you typically don't talk about specific customer types, but there's lots of discussions about GLP-1. So I'll try to ask in here another question on this. But any color just how you see this evolving? There's some oral GLP-1s that could potentially come to market. How does this maybe impact the larger demand? Is 10% to 20% of these products shifting to oral the right way to think about it? I guess, just when you look into your demand algorithm, how should we think about that?

So I think that when you -- you're right, I mean we try to refrain from talking about any specific disease or drug category. So look, all things being equal -- and they rarely are -- drug companies, patients, typically prefer oral. But then there is a reason why injectables are growing, because the effectiveness, the bioavailability, the amount of API required per dose to get that whatever effect that they're looking for, trying to balance that versus potential side effects, all of those things come into play. And so I think that all of those discussions have to come in, which is why we always refer those type of questions on the specific to the drug company, because really they monitor and make those decisions. What we do is we talk with all of our customers. We -- because of our position and our leadership, we share with them our expansion plans. Some things take time to build out capacity. And then on the flip side, what we ask of them is to get visibility on their near, mid- and long-term expectations. And for customers that have larger launches or larger expectations, the touch points are more frequent. And we're always adding that as we're trying to do our capacity planning. And so what we've said and been fairly consistent here over the last couple of years is that we are adding HVP capacity. There has been a particular focus on plungers. And just recently, we brought online one of our -- into one of our centers of excellence in the United States, our Kinston, North Carolina plant, NovaPure plunger capacity.

Great. And I want to dig into all those pieces and maybe just 1 last 1 here to ask. So I think broadly speaking, you're in about 90% of the biologic filings. Any thoughts just on market share, how that is, maybe even GLP-1s or other products there on that piece?

Sure. The way we track it is our participation rate. We really focus on -- and our partner, Daikyo, and how we're tracking with respect to NMEs, new molecular entity approvals. And if you look at year-to-date, if you look at last year, if you look over the last 5 years, it's a really high participation rate. And we think that that is probably a good proxy for market participation.

Great. So moving beyond the GLP-1s. And you guys just reported a nice 2Q earnings. I guess, just how should we think about the revenue cadence for the remainder of the year between the 2 quarters? I know you have some dynamics, capacity coming online, you have COVID rolling off, how just we think about that?

Well, I think, take a look at -- we believe the second half will be greater than the first half. And we have historically seen seasonality of our business where Q2 tends to be the largest quarter. Q3 is less, and then it kind of reverts back to a higher level in Q4. That seasonality still exists as we look at 2023. However, we do have some -- and as Quintin indicated earlier -- investments that we've been making, one in particular is in Kinston, North Carolina, with NovaPure plungers, that as -- where we sit today, as I'm speaking, we are ramping up on commercial manufacturing and supporting our customers. There is demand for the products. That's why, obviously, we put the investments in. And we believe that, plus getting our lead times back in line to pre-pandemic levels, which we believe will take till the end of this year, will give us a stronger performance in Q3 due to that. It's going to offset the seasonality. So the way I would look at it is Q3 will be similar plus minus to Q2. And then Q4 will be stronger. Therefore, the second half will be stronger for us.

Appreciate that. And with the capacity coming online, and I guess specifically Kinston. Any way to -- I think you mentioned -- so just to clarify, is that doubling your NovaPure capacity once that would be fully online? Or how should we think about that?

Not NovaPure in general, but around our NovaPure plungers at that site. So it gives us a significant expansion. The way that we made the investment is that we have the infrastructure expanded, a modular approach. We have installed new equipment and technology to be able to produce the product with new team members on site if demand continues to accelerate. We were able to install additional equipment without other infrastructure required. So I think we've really purposely did a really good job on staging the investments, and as we go forward, to stay ahead of the curve versus getting behind it like we were in the last year or 2. So really confident we're positioned well now for NovaPure plungers.

Great. And then just maybe broader capacity, because you also have Jersey Shore, Pennsylvania and Singapore, you mentioned. Just any additional color on just like, I guess, on the demand you're seeing here, maybe how much is committed or any way to quantify that?

The way I would look at it, this year we've committed to about $350 million of capital, which is, as you think about it as a percentage of sales, is higher than we've articulated in the past. We were looking at about 6% to 7% of sales for capital for a business growing about 7% to 9% organic top line. What we're seeing today with the $350 million like we saw last year, is that about 70% of those investments is around growth. I think historically at West, we were about 50-50, 50% on growth, about 50% on maintenance and IT. We're seeing heavier emphasis on growth, which is a good thing. It means that we are working with our customers anticipating additional launches in the near to midterm time horizon. So we're making investments. It's not just in Kinston. These investments take 1 to 1.5 years from a modular point of view. We're making investments in our Waterford facility as we speak, Jersey Shore and Pennsylvania, also significant investments in Singapore, which is a great manufacturing platform for us for all of Asia, but other -- able to export it outside of Asia. So it gives us the ability to support the growth that we're seeing with high-value products. It is -- disproportionately the investments are around plungers, not just NovaPure but other types of formulations, to be able to support growth that we're seeing in the biologics and other areas of the markets. So we're excited with these investments. There's multiple moving parts, but that's a good thing for us as we continue to look for growth in our organization.

Let me add a little bit to that. I mean it kind of underscores the fact that we don't have really high concentration either to a single customer or a single drug class. And the growth that we've been seeing since 2019 has been fairly widespread. And so the capacity that we're adding enables Westar quality, RS/RU. It helps our Envision capabilities. It works on -- at the FluroTec level as well as the high profile NovaPure that we talk about. So it -- a lot of attention gets put on to just Kinston, but we have a lot of efforts and a lot of projects going on throughout our network, even in some of our standard areas we have projects going on. So we have a very robust CapEx expansion right now going on.

And I guess just with that robust CapEx expansion, and you've talked about this plunger demand. But I guess even within HVP capacity that you're bringing on or just broader current capacity, any color on what products you're seeing the most demand there within your portfolio?

As Quintin mentioned, it's really across the whole portfolio. And it does show the robustness of how we're penetrating into the pharma, the generics and also in the biologics. I'd be remiss if I didn't say we are continuing to add capacity in contract manufacturing, but these are very long-term agreements. Our customers are also installing capital in these investments. So it's a joint long-term relationship. So it is across the spectrum. But I would argue that most of the investments are more the higher end of HVP, which is positive because, as you know, we've been seeding the market. Where we win is in the pipelines. And we continue to see the market with the highest end of our high-value products. We're seeing the high participation rate across the board, which is exciting, and we're preparing ourselves with customer conversations of additional launches that we're looking at that are on us today and also into 2024.

And HVPs are roughly about 73% of the mix today, I think you ended the year at 72% last year. Just any color on where you see the possibility for the penetration to go here? And then what would be the dynamics for maybe top line or bottom line impact from that?

We -- HVP growth continue to be strong double digits. We see the key drivers of the growth really is the biologics and biosimilars space. We're also seeing greater penetration in generics, and that is leveraging our AccelTRA and other parts of our portfolio in HVP. So we're quite confident in our growth profile of high-value products, which is actually quite exciting. So we'll continue to invest in those areas. But it is kind of across multiple markets, multiple drug molecules, multiple customers and multiple geographies. We're seeing the penetration continue to stay very high in that area.

And I guess just maybe back to another question just on the seasonality in the second half. I believe that you mentioned that you're not seeing the normal plant shutdowns this year for different maintenance [ to ] keep the capacity coming online. Just any way to run through the color there on that?

Well, I'll start with this. We are still shutting down plants in certain parts, like in Europe, to make sure that we are managing the maintenance because that's so critical to keep our -- the level of quality that we are producing each and every day and our customers are accustomed to. So that is important for us to continue to do so. We do have larger vacation times, I guess you'd want to call it, in Europe at this time of the year. But -- so we're not pulling back on our maintenance and shutdowns other than we have installed capacity that is ramping up to offset that this year, and particularly in Kinston and a couple of other locations. So that's how -- it's the puts and takes. I think overall, it brings it to a higher level than we would have anticipated last year or the year before. But yes, definitely continue with the maintenance and the investments in those areas.

And GLPs get a lot of talk, but another area for driving that high single-digit growth you talked about have been biosimilars. Just any additional color on how you see biosimilars continuing to impact the market there, maybe near term or long term? Maybe I'll pause there and then follow up on this.

We still have a very strong participation really in biosimilars like we do in biologics. It's -- from a value proposition, our portfolio, our technologies jointly with Daikyo, really resonates well with our customers in both areas because of the way it is able to support the molecule, right, as they launch. So we're excited about the biosimilars as much as we are with the biologics. We're well positioned. It's not a different product category for West. It's a similar value proposition, similar products that we are producing, such as NovaPure, off of our existing lines. We don't have to have any dedicated equipment or any particular customers or launches. So it fits really well with our business model, and we're excited with the growth opportunities in biosimilars as we are with the biologics.

And you kind of touched on there on the end, but if you're not, say, the non-HVP product and the originator or it was transitioned, usually do you come in then on the biosimilar? Would it be an HVP product? Like what level of HVP, any color on that?

Yes. So you're right. When you think about NovaPure, the journey of NovaPure, there's -- we really launched that in, let's call it, 2016 and beyond. So many of the molecules that maybe are proved and on the market and commercialized prior to that would not be leveraging NovaPure, for the most part. As customers are looking to transition to a biosimilar, we are -- the discussions we have with our customers start with NovaPure, as in any other pipeline opportunity. And so there is that transition of a mix effect that's going to occur within our HVPs because of that effect. As biosimilars are being approved, we're seeing a higher leverage and usage of our NovaPure portfolio.

And then I guess just on pricing, I think you're targeting still this year, 5% to 6% pricing increases. Just any thoughts long term on how the sustainability of the pricing you've been able to capture here?

So let's kind of start with, historically, a few years ago the company would get about 1% to 2% price per year, often at the lower end of that range. We have talked about looking at price more strategically, and we have brought in teams to look at that. And over the last few years, I believe we have been more strategic on pricing, to be a little bit better than what that historical range has been. Then you couple it with the inflation pressures that have occurred, for not just us but the whole economy, over the last couple of years, and we've been able to then take that and be able to use that structure that we have with pricing to be able to help offset some of the inflationary costs that have come in. So this year, what we have said is that it is going to be 5% to 6%. That is markedly higher than where it has been, but we're also experiencing inflationary issues, some materials, some supplies, some utilities, but in particular, labor, because of the labor demands here over the last 2 years. And so that has driven us to where we are. We haven't given any forward guidance on where it could go. But again, I'll just leave it as that we continue to believe that we can continue to be more strategic, certainly, than the historical 1% to 2%.

And Eric, you touched on this a little bit in the beginning, just in the overview of the demand market. But you recently increased the contract manufacturing piece to that mid-single digit, high single-digit growth there. Just any additional color on what drove the increase in your outlook and the expectation for that segment of your business?

It's these long-term agreements that we're signing and starting to invest in. So we do have visibility. That's one part of the business where the installed equipment, new facilities, are really dedicated to a particular product and a customer. And these are very long-term, i.e., 5, 7-plus year agreements. And so with that being layered in and knowing that we are -- we'll be turning those on, and the requirements to get to close to 100% utilization as soon as possible, gives us pretty good confidence of moving that up between mid- to high single digits more longer term. The particular area around auto-injectors is probably the biggest driver when you think about the injectable medicine space we participate, the number of auto-injectors, but that's probably the biggest area of growth we're seeing right now in CM.

And maybe moving to a little bit below the line and some of the impact on the HVPs there. Can you just remind us the impact on HVPs on margin versus maybe non-margin mix? And any way just to quantify that, let's say, every 100 bps increase, how that impacts? HVPs on margins, just how should we say, like every 100 bps of penetration increase there, maybe the thoughts on that?

Yes. Again, so a couple of things there. I think that when you have a top line 7% to 9% construct, organic sales consolidated, that presumes that HVPs are growing north of that and the standard product is growing less than that. So let's get away from percent of sales. Let's just look at the drivers, plus or minus to that. And so when HVPs are growing in the double digits, given their margin profile, yes, the construct would yield about a 70% to 80% -- 80 bps per year of gross margin improvement. And then with other operational efficiencies, plus a little leverage on SG&A per year, then that gets us to the 100 bps plus per year construct. So nothing has changed. You're absolutely correct. HVPs are going to be the driver of top line as well as gross and operating margin expansion.

Maybe just now switching to some of the more macro near term. Any updates on Pfizer, the situation in Rocky Mount, with the recent storms there? Luckily, no one was hurt, but any of the thoughts on the broader impact and any updates since the quarter there on that?

Yes. No, it's devising to see what impact it had at that site, and so we reached out immediately afterwards. Since you know we have our own facility, Kinston, North Carolina, it's about 50 miles or so from their locations. So our teams know each other very well, and we reached out and determined what we can do to support them in any given way. And I think the whole supply chain is ready to react to build support in a meaningful way to make sure that there isn't a disruption for them. But yes, it's more -- we'll see more as we go down the road and we're ready to respond.

And any color just on -- we've seen some destocking from those life science tools companies that are facing biologic customers, just how are you seeing any impact from that?

What we're seeing in the working capital or working management, capital management. When you think about -- obviously, COVID is an area where we're seeing destocking. And last year, we did about $388 million of COVID-related materials. And this year is going to be -- we're forecasting about $60 million. So there's an effect there. We are seeing some destocking in areas around the disposable medical devices or, call it, standard products for us. It's another area we tend to see a little bit of this happening. But these amounts are not material to us. We're able to manage through that, work with our customers, keep our operating facilities in check if it will have an impact on site, we would do work with our customers. For the most part, when you think about during the COVID time period, we were getting behind on our lead times. And so many of our customers' safety stock levels did not get escalated or get larger than they anticipated during the pandemic. So we're actually in a good place right now. We're -- our lead times did get a little bit large. We brought them in. We're working down the need for additional materials with our customers. So right now, where we stand, what we see is not a lot of destocking with our products.

And I guess while we're on the near term on the macro, I think China is a small portion of your revenues, but can you remind us what the exposure is there, and just any color on the outlook for the China market?

I'll cover that. Yes. So I think it's a small percentage of our business. We do have 2 manufacturing plants in Qingpu just outside of Shanghai. That really supports the local market with certain product portfolios that's focused in that area. We actually are seeing good growth outside of COVID. That's another part of the world where we're seeing a decline in COVID. But net-net, we're seeing relatively neutral. We're not seeing a reduction. Our reliance on raw materials coming out there is less. A lot of our sourcing of our materials are really co-located with our manufacturing plants on the continent. So we have less risk in those areas. But it's a small piece of our business. So it's really not material. We haven't really called it out. And frankly, we're not seeing a big change on the demand profile in China for us today.

Yes. So John, as a reminder, I mean our exposure, in China as well as the rest of the world, is mostly on commercial volumes. We do sell some to customers that are doing preclinical and clinical trials, but that volume is small relative to the rest of the business. And we don't have really any sales to speak of at the discovery level. And so -- to compare and contrast with other life science tools companies.

And that's great, it leads into the next question. West is very highly levered to those commercial revenues. Any just impact you've seen from, say, funding or even slowing of R&D from pharma customers? Has that impacted the business at all?

No. No, it has. As we mentioned earlier, our success really is in the pipeline. So you're right, it's an important area to be focused on. But the -- from a revenue and profit perspective it's very small, minimal impact. These volumes are very limited. We are seeding the markets with Ready Pack and other materials, but it's really meaningful when it gets into the commercial stages. So today, we do believe the engine of innovation continues to thrive, and we'll continue to support it short term and midterm.

And might as well one on COVID while we're here. Just you've cut COVID guidance this year. When you look at now 2 quarters in, any way to think about the endemic run rate from here, and just where does COVID -- see the tracking from here?

Yes. I mean, look, I think we, along with all of society are hoping that we are getting to this lower phase and kind of situation with COVID. So for the back half of the year, the expectations are really small in terms of our COVID sales. And as Eric said, we definitely have seen destocking in that area. In the event that the pandemic rears up again, and if there is a need for vaccines and treatments, we'll be ready. And that is our commitment. We'll be there. But right now, nothing to add.

And I wanted to ask one on the Corning collaboration and the West Ready Pack, the Corning Valor. Just any color on demand there and just how this could potentially play out in increased demand on HVPs or NovaPure?

Yes. It's an exciting area of investment that we're making, working with Corning. The concept there is that we do believe that there's a drive towards integrated systems. And the elastomer component is a critical element of any type of system, whether you're talking about a cartridge or a prefilled syringe. And working with Corning gives us the ability to bring the glass element, which we currently do not have. So we're excited. We've had a couple of launches around the vial configuration, and we'll continue to work all the way up to a fully characterized prefilled syringe in the near future. Our focus is really, again, to seed the market and then bring the demand in through new approvals. But we're in a very unique position with that relationship to ultimately get to what we believe is a one drug master file approval approach with our customers, which is resonating very well in the market today. The question is how fast can we go? And so we're deliberately -- we're working swiftly with our -- internally both at Corning and at West, but also with our customers. So we'll -- more to come. But it's very early at this point in time.

I guess just broader on that and moving to that, the 1 product approval, just any changes in the competitive dynamics in the broader industry that you've noticed now that we're actually ending the COVID pandemic?

Look, we have really formidable competitors in the marketplace, really good companies, well run. We don't see, ourselves, we don't see a change in the dynamics of market share in particular. We do monitor very closely what we call participation rate of new approvals. And we continue to have very high acceptance of biologics. Obviously, other NMEs in the small molecule area and also seen a little bit of a tick up in the ANDAs or the generics area. So -- but we don't -- from our lens and our position, we don't see any major shift at this point, particularly on the elastomers of our business.

And a question we have here from the audience, as your lead times are returning back to those normalized levels, can you speak into any of the visibility into customer inventories or other metrics that might insulate less from lower ordering patterns, which have come up in other parts of the pharma manufacturing chain?

Yes. So one encouraging area is that because we're bringing the lead times down, customers are getting more confident in shorter lead times, therefore we're having more frequent more near-term orders versus very elongated 1, 2 years out type of approach. That's what we wanted to get to. So it allows us to be more flexible with our operations, it allows us to be more responsive with our customers' needs, allows them, our customers, to not have to build significant levels of safety stock. And so we're in a much better position today and the visibility remains -- continues to remain very high. We do interact with our customers frequently on not just current drug molecules in the marketplace, but also planning for future launches for near and midterm, because sometimes we will have to make investments in advance to make sure that we can handle the volumes that will be asked upon us. So the lens is very good for us, and we continue to build off of that. And I think that's been one of the biggest changes we made in this organization over the last 5 or 6 years, which is really paying off today.

Have you quantified what lead times are now, let's say, where they were height of the pandemic, 2020, 2021, how they've come down from maybe months out in ordering?

So it varies by SKUs. We had some certain HVP categories that the lead times exceeded 40 weeks. And what we like -- we would rather see in some of those cases to be between 10 to 14 weeks, maybe sometimes between 8 to 10. And so our expectation now is that as we've been bringing on HVP processing capacity, and that began last year and into this year, as we brought in now more plunger capacity and NovaPure capacity, that by the end of the year the majority of our portfolio will be getting back to more normalized lead times.

And we've touched on lots of different parts of the business. One we haven't talked on is the generics segment. Just any color there on the year-to-date performance and outlook in the second half?

Yes. So I think generics has been really -- so if you look at it, excluding COVID-19 impact, it has been really strong double-digit growth for generics. Part of that has been a benefit from the fact that we've been able to work some of the lead times down and bring up the safety stocks in some of these long lead time items that -- so now, stocks are being replenished -- so -- and then the rest of the underlying growth continues to be good because the volumes have been good. The number of ANDAs and our participation rate have been good. And the conversion of some of these customers moving to like a Westar RU format, a ready-to-use format, have been good. And that -- those have all been drivers. So it's kind of a combination of all 3.

Great. And we're reaching about time here. Just last question, maybe just more, Quintin, just follow up on the margin piece. Can you just run through on just -- I guess we talked to top line cadence second half just on how margins should track. Should they track in line with [indiscernible] news, with the dynamics of capacity coming online and thoughts there on that?

Yes. So look, if you look at it from a typical seasonality, and if you look at a typical West year, which has been a long time since we had a typical West Shield with COVID going up, coming down, all that, the second quarter typically is our largest sales quarter. It would typically our best gross margin quarter because it's also we have great utilization, more uptime, good absorption. The lowest quarter typically is Q3 because of the summer shutdown, especially in Europe, and Q4 is the second lowest. So those dynamics of the seasonality will continue, but the drop in gross margins will not be as dramatic as in prior years because we are bringing on capacity for HVP. The implications for -- in our guidance is that capacity is going to come on at nice incremental margins, but not the full contribution margin, given the fact that it's a new facility, and you always have startup costs with the new facility. So that is the net-net of why sales will be plus or minus where Q2 are, better in Q4, but margins will be just a tad less than what we saw in Q2.

Great. Well, I think that's a great place to end the conversation. Eric and Quintin, thank you very much for joining us today, and thank you for those in the audience who listened in.

Thank you very much for having us.