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

Good morning. Welcome to Jefferies 2023 London Healthcare Conference. I'm pleased that you're able to be here and appreciate your attendance. My name is Dave Windley. I'm with Jefferies Equity Research in the States. I've run our small Nashville research office, and we do a fair amount of health care research out of that office. Here with me today is West Pharmaceutical Services and management team: CEO, Eric Green; and Head of Corporate Development, IR, Quintin Lai. We're very pleased to have you guys here. You're regular attenders at this meeting, and so thank you very much for being here and giving us your time.

Eric, I thought I'd just start us off with kind of a perspective question. West is kind of a pure play on the injectable drug space, the injectable drug space keeps getting hotter in general, but there have been a couple of really big bangs of COVID and now GLP-1s that have come along that have added to what is otherwise still a fairly steady growth environment. So maybe talk about what the experience has been in making that transition.

Yes. Great. Thank you, Dave. And first of all, thank you for the invitation. Enjoyed the meetings here today so far, they've been very productive. And my colleague, Quintin Lai will be here also to assist in the questions. But it's been an interesting journey the last couple of years, Dave, and it really kind of shows the criticality of West in the injectable medicines space. We're in a very fortunate position. When you think about the marketplace itself, it's one of the fastest-growing spaces within health care, the injectable medicine space. If you go one level below that, you'll find that the biologics space is even -- it's the fastest-growing subsegment of the injectable medicine space, and we're very fortunate to be positioned very well from our scale, our quality and our technology to be the market leader in global containment and delivery devices in the injectable medicine space. So clearly, we have a very strong position. And the COVID pandemic really challenged the organization in multiple ways, but I couldn't be more proud and humbled on how they responded, and really driving a 24/7 mentality to make sure that we are able to support close to 8 billion doses of COVID vaccines across the globe. While our core business without COVID continued to grow double digits over the pandemic period. And what that tells us is the durability and resiliency of our business model allows us to react to these mega or are these large changes that could occur with new launches of new molecules. So we're very well positioned, Dave. Fortunately, we've made enough investments. We're optimistic about our investments to be able to continue to stay ahead and support our base business, our core business, but also if there is any surge of demand of any particular new drug launch that could occur, whether in near term or more long term. So it's a very good position to be in at West, and we're ready for the next challenge.

Excellent. So you've talked in public environments about the escalating interest in your highest value product. So part a function of the biologics growth that you just described, part a push in the regulatory environment toward quality. But maybe talk about how the demand uptake has intensified in FluroTec and NovaPure, your very high -- highest of high-value products and how you put capacity in place to be able to address that?

Yes, so we're really good at seeding in the market. As you know, we are working with customers early on from development all the way up to clinical through commercialization. In those early phases, we've been seeding the market, whether large, medium or small firms' customers with NovaPure, particularly in the biologics space. And that launch was literally 2016, 2017. As you know, it takes a few years to get adoption in the marketplace, and we're seeing that become realized today. And so when we think about new approvals, particularly in the biologics space and biosimilars, the residents where the consistency of using NovaPure has allowed us to see significant demand increase of that part of our portfolio, which is the highest end of our high-value products today. Now for the future, we have more work to expand that. But today, NovaPure is the most -- the highest quality product that we provide in the elastomeric area of our business. And along with that, we've been adding capacity at our centers of excellence for our high-value products, particularly one that we just recently finished. It was with Kinston in North Carolina in the U.S. We have significantly added capacity around NovaPure plungers because as we think about the future growth speaking with our customers, it is around the HVP plungers, and NovaPure plunger is one of the premier offerings that we have. So we feel good about the investments. We continue to invest -- about 70% of our capital investments is around growth. And which if you think about it a little bit further, most of it is around the mid- to higher end of HVP. As you alluded, most, if not all of the approvals that we are on, particularly in biologics is using FluroTec technology all the way up to our NovaPure product offering. So that we're very well positioned today. And with the recent expansions, we can handle additional demand growth over the next few years.

So I'm going to linger on this for a moment. During COVID, the conversation in terms of high-value uptake was, I'd call balanced between FluroTec and NovaPure. And over time, your comments have increasingly kind of migrated toward NovaPure. Our clients -- I mean, I think FluroTec is maybe more often than not incorporated into NovaPure, so I know it's in there, but are clients kind of jumping over FluroTec and going all the way to NovaPure now?

Yes, the technology itself of FluroTec is embedded in NovaPure, but it's the entire quality of a design concept that the product offering offers. And therefore, we're seeing more adoption at this point, leveraging our NovaPure portfolio. So that's a correct statement.

Yes. Okay. And I'm going to bet you're going to beg off on the specifics, but the economics for NovaPure over FluroTec are an increment higher. Yes?

Yes.

I'd love for Quintin to put numbers on that.

Well, I mean, the thing is that when you're talking about NovaPure, you're talking about quality by design. And so we're putting in checks and balances on every stage of the manufacturing process. And then what comes out is a product that has tighter tolerances, lower defect rates, higher performance. And so because of that, we do get a value proposition to the customer as well as for ourselves. So in some cases, NovaPure gross margins can be 70% and even higher.

Right. Great. Segues really nicely into my next question, which was going to be around pricing. So the company, I've covered you for 12 years or more. And pricing for the vast majority of that time was in the 1%, 1% to 2% region. And in this last year, I think, 1 year to maybe 1.5 years, the price component. So separating -- leaving mix aside, the price component of your increase has steadily stepped up. So maybe talk about the pricing posture and as your thinking has evolved there.

Yes. I'll start here, Quintin. You're right, Dave. Just kind of looking back when we started, Quintin, it was probably a sub-1% net price contribution at West and we've steadily increased that, but I think it's been more of a strategic focus in the last few years. We're looking at different parts of the portfolio, more of a strategic approach versus just across the board of leveraging opportunities to increase prices more in line with what we see [ as ] inflationary costs and also to cover the additional benefits that we're providing with the product. So this year, we're between the 5% to 6% corridor. I think last quarter it was about 6.5-or-so percent net price contribution. Year prior, we're roughly about 3% to 4%. So I do believe the way that we've structured and the way we're looking at our portfolio today and see the opportunities, whether it's geographic, whether it's certain customer segments, certain product segments, we do believe that we'll be north of the 1% to 2% that you were accustomed to years ago. Going forward, it will be modified as we think about various inflationary costs. I mean, obviously, this year, we were -- several industries were hit with additional inflationary costs, we were able to pass on to our customers. And that will be kind of the lever as we think about going forward if there needs to be more, and we have the capacity to put more into pricing. I do want to just reiterate though, Dave, when we talk about net price contribution, this does not include, as we move customers up of our high-value product curve, we consider that mix. So any time we're able to get a better ASP, better margin on the same number of units, we do not categorize that within our waterfall charts as price, we consider that mix. So this net price contribution is truly a reflection of a year-over-year price.

Yes, definitely a good point of emphasis there. So you mentioned the inflation parts of that. So if I were to translate what I heard from you just there, 5% to 6% probably had some elevated inflation elements in it. Go-forward price, maybe not necessarily as high as the 5% to 6%, presuming that the inflation has moderated as it has, but certainly better than the 1 -- or 1% to 2% that it has been in the more distant past. Is that's the right interpretation?

Correct, that's the way to look at it.

Yes. Okay. And you mentioned more strategic and kind of targeted approaches. Are you -- I mean, is it better pricing power at the highest end of your high-value products? And so taking more price there or in certain therapeutic categories? Or how do you -- you mentioned not broad-based anymore, so how should we think about the targets for that price increase?

Yes, it's not -- I would not classify as the higher end of our portfolio. It's all parts of the portfolio, but it is very targeted to certain segments and certain parts of the portfolio. It doesn't necessarily -- would translate to the HVP product portfolio. I will say this though, we do not have list price. And so when we engage with our customers, we look at the value proposition, and we set the price starting point based on what we're providing the customer at that particular time. So the entry point may not be consistent from one -- with one customer to the next.

Interesting. Okay. And then thinking about your long-range growth targets, 7% to 9% revenue growth, kind of 100 basis points of margin expansion, focused on the revenue growth part of that. I think when you first set that, would have been in a period where this price contribution would have been on the relatively low end. So if you're getting an extra couple of points, a couple, 3 points of price benefit to your top line, how does that incorporate within the 7% to 9% long-range plan?

Yes, so there are a few ways to look at that long-range plan. I mean 7% to 9%, typically, volumes are growing in the low single digit 2% to 3%, it presumed pricing at the 1% to 2% range, and then the balance of it being mix. And as you go forward, again, if you affect any one of those components, price, volume or mix, then we would probably go back and reevaluate. But all those things put together is how we take a look at it. If you look at it from a market unit perspective, that assumes biologics growing low double digits, generics growing kind of mid- to high single digits and pharma growing low to mid-single digits and contract manufacturing going kind of mid-plus. So the different ways to look at the 7% to 9%, it's a long-term contract, Dave, and that's how we kind of look at it.

Yes, very good. So certainly, the price element of those 3 contributors to growth hasn't gotten worse. We can say it's a net better beneficiary of your long-range plan.

Yes, I mean -- so as Eric said, I mean, historically, we've been closer to the 1% price per range, and we think that we can do strategically more. And then depending on -- and as we demonstrated over the last couple of years, if we get inflationary issues on material, shipping, energy, labor, all of those things, we believe we have a mechanism to also pass that through.

Got it. Okay. Getting a little more specific to the recent performance. In the third quarter, you called out some weakness due to customer cadence around restocking, we kind of distinguish between restocking and destocking. I thought it might be a good opportunity to distinguish the difference if it is important, and then what are those areas where you're seeing that stocking cadence change?

And there's 3 areas that we're seeing movements when it comes to order patterns with our customers. So just to level set, we're made to order. So we have visibility over the next, call it, 4 to 8 quarters of demand of our customers. And there's some variability from quarter-to-quarter, but we do have that visibility. And when you think about the 3 of them referenced, one is there was a destocking effort this year around COVID. I think everybody understands that. So last year, we did about $388 million of COVID-related materials. This year, we're guiding about $68 million. So it's a $320 million headwind, hence, we're still growing this business in 2023. And so that's 1 of the 3. The second one is what we're working with our customers is during the COVID period, our lead times as a make-to-order manufacturing process elongated. So going all the way out to, call it, 40 to 50 weeks. We're working with our customers during that period of time. We had to identify which orders can we fulfill, at that time so we don't have any stockouts for our customers, but also, importantly, we're able to get materials out for the COVID vaccines. As the COVID vaccines kind of come back or reduced, we're able to rectify those -- correct those lead times, and we're back down to the normal pre-COVID period of time, give or take. And also with the capital investments we made, allowed us to get more capacity in our facilities because, again, the core business is growing double digits consistently quarter-to-quarter last 2-plus years, 3 years. The third one, we're seeing working capital to a certain group of customers, particularly around disposal medical devices. This tends to be our standard products, lower margin, large volumes, but that certain particular facilities we have around the globe, these particular products just -- and these were like the nonregulated products that we are providing our customers that are going into whether clinical or a hospital setting. And that particular part of portfolio, we're seeing more working capital management at this point in time. So those are the 3 moving parts that we're dealing with today, and that's -- hopefully that clarifies that.

Yes, it does. That's great. Is it possible to have visibility into how long this lower order pattern will last before these clients have gotten their inventory levels to what they want them to be?

On the third bucket, the first bucket we know, but the third bucket, we are -- that's unknown at this point in time. There's a little more variability. Again, it's a small piece of our business. But when it's coming to restocking with our customers and just building up their safety stocks, that's why in the last call we had, we gave some indication that next year, we'll be within -- looking at our financial construct is intact, so the 7%, 9%. So you can assume that, that goes back to the kind of the traditional growth we're seeing with the low to mid for pharma, mid to high for generics and double digits for biologics and mid to high for CM, that algorithm. So that whole building up the safety stock, we're pleased, we feel that we're close to completion there for our customers and now we'll probably be back to reordering patterns consistent with what we've seen before.

Got it. And kind of relatedly, but maybe a broader version of the question. Beginning, I think, when Bernard joined you in the CFO seat, there was a pretty concerted effort around investments into visibility, connectivity with clients, visibility into client supply chains and being able to kind of manage that cycle a little bit better. Maybe describe those efforts and what visibility they give you now?

A lot of that infrastructure that has been put in and continues to progress was instrumental in us being able to react appropriately when the COVID surge hit. Because as Eric said, we were able to manage supplying COVID vaccine manufacturers, COVID drug manufacturers as well as make sure that all of our other customers got some product. Maybe they didn't get everything they needed in their terms of safety stock. What we -- to the best of our knowledge, we don't believe a drug got stocked out because they could not get product. And I think that, that was in part because of the team and the infrastructure, the analytics that our team has put together. And it's composed of not only looking at order patterns, but it's also composed of getting feedback from the customer. And we've increased that feedback loop. Eric and I just talked with our -- some of our commercial leaders last week. They were coming back from a large conference in Barcelona. Huge difference year-over-year. Last year, it was West, when are you going to get our supply up again to more comfortable levels? This year, West, okay, you're better now. And so that's the progress that we're making.

Let's move on to capacity. So Eric, you mentioned Kinston. You mentioned 70% of CapEx is generally going toward growth investments. So maybe flesh out -- Kinston is one that maybe people are more aware of, just top of mind, but maybe the broader targets of that 70% of CapEx for growth?

Yes, so if you -- so this year, we've spent about $350 million in capital, CapEx, and it's really allocated, again, 70% towards growth-oriented investments versus maintenance and IT infrastructure. That's unusual for West because historically, we've been around 50%. So this is the new algorithm that we're working with. And I'm actually quite excited about that. If you think about where it's been invested, so the 5 centers of excellence for HVP. If you think about -- we talked a lot about Kinston because we had some tours there. We opened up the doors and gave visibility of the types of investments we're making there. But that's consistent to what we're doing at Jersey Shore. Here in Europe, it's in Germany and also in Ireland. And we do have some investments going on in Singapore. So that is to help continue to fuel the growth of high-value products, particularly around plungers is pretty much the primary area of focus, and also HVP processing and finishing. The secondary area that we have invested growth capital is around contract manufacturing, particularly around -- here in Europe it's in Dublin, and also in the United States it's around Grand Rapids, Michigan primarily. And this is really around auto-injectors. And we continue to invest capital in that space. We currently have major projects going on in both locations as we speak. So it is, again, around growth, and it's spanning from HVP portfolio on the [ last-mile side ], but also touching our Contract Manufacturing business for the -- particularly around the auto-injector space.

Yes. On the contract manufacturing, are the economics of your participation -- I think, as a premise you've described that in those cases, it's the customer's IP and they're hiring you among a few other vendors to produce those devices, those -- that molded plastic for you or for them. Are the economics on those auto-injectors, say, better than your current Contract Manufacturing kind of margins, profitability?

Let's just say that they're within the range. I don't want to specify one way or the other. But they're within the framework that we've established with that business going forward. As you think about contract manufacturing years ago, a few years ago, we were kind of a mixture of the pharma, health care space, but also in consumer products. We really deemphasized consumer products over the years, focused on the pharma segment, which is consistent to the customers that we are servicing in the proprietary side. So the economics are relatively consistent to what we see within contract manufacturing today going forward.

Okay. I want to ask -- I know we're getting towards the end here. Let me just ask one more around, I'll call it, integrated delivery systems. So this is, I think, a long-term strategic evolution that you all are trying to pursue through things like SmartDose and partnerships with Corning on Valor Glass. Maybe just set the table on where you see the world going in terms of those integrated delivery systems and how far along you are in terms of getting customer updated.

You want to start?

So twofold. On the area of wearables, Dave, that is a differentiated product. It is something that is relatively new for the marketplace, and it serves a purpose of enabling the transition from IV-based drugs to subcu-based drugs. And so it really gives the health care provider as well as the patient different options to get the drug. And so we're seeing good traction there. We already have 4 approvals. We have an active pipeline. On the other area of integrated systems, that is where you're combining elastomer with glass. This is again new to the industry, and it's being driven by a couple of things. One, the regulators continue to push to see that when you assemble components together that they work together as a system. And so they're pushing the drug companies to show that they're a system, and the drug companies push the suppliers to go in the system. Regardless of the fact that right now, it's all ad hoc, everybody doing components, just on a components basis. We think that by creating this truly integrated system, we could help address some of those issues. And then second, we believe that there's going to be streamlining for the customer to be able to have one filing, one drug master file, simplicity in their supply chain and more transparency on how things work on their side. So again, we -- it's a long-term process. It's going to take some validation, but we believe that it could be the next rung for our HVP.

Excellent. All right. I think I'm right up against time. So we'll call it there. Thank you for your attention and attendance.

Great. Thank you, guys.

Thank you, guys. Talk to you soon. Feel free to reach out.