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

[Audio Gap] Head of Investor Relations. Gentlemen, thanks for joining us.

Thank you, and thanks for the invite. It's good to be here.

It's great to have you. I guess just our standard question to kick things off. 1Q results came in ahead of expectations. You had an overall organic decline of negative 3. You maintain the organic guide for the year for revenues, but you raised the EPS by $0.13. A couple of moving pieces in that. Could you just give us an update on how 1Q played out relative to your expectations?

Yes. 1Q was pretty close to where we thought it would come in a little bit stronger. We saw some orders that we had expected probably to come in Q2. Customers asked, could we produce them in Q1 and deliver them, which we did. So good performance based on where we thought we would be and what we were experiencing. On the EPS side, again, pretty much in line with what we thought it would be in stock-based, compensation tax benefit was in there and that layered into the overall change in guidance for the full year. But as we reaffirmed for 2024, the cadence that we talked about in February still holds true for what we're seeing materialize as we move through the year. So first half a little bit weaker than the second half. And we haven't changed our view on that at this point.

Okay. And then anything you can say in terms of order books, how things are trying to -- visibility into end markets? I know it's a little volatile week-to-week, month-to-month, but...

Yes. I think it's the same as what we've been communicating over the last couple of months. As we move into the second half of the year, when we look at our orders on hand as a percent of forecast for the second half of the year, that's trending a little bit ahead of where we were at this point in time in 2019, pre-COVID. So we're -- we've seen that continue as we've moved through the last number of months. So again, no change there, and that ties into how we're guiding for the year.

Okay. All right. And probably the high debate point on the stock these days is a destocking situation. What you're seeing in the end market, we've heard mixed commentary from some of your other packaging component manufacturers. Could you give us an update into visibility into customer levels? How do you manage that? And how do you gain confidence that you've got a good sense of what's going on there?

Yes. So we're constantly in communication with our customers, assessing where they are, what is their demand, what is the timing of that demand. So that's an ongoing process. And then we correlate that to what we're seeing in actual orders coming through, as I just mentioned, as we were seeing what's coming through in the back half of the year and is all of that tied together. Again, what -- again, it's evolving. It's something that we monitor very closely.

And Mike, maybe I'll just add to that because we've had some questions earlier today, customer concentration with respect to this destocking. And what we've seen is that it's across the board for us. It's pharma companies, it's generic companies, it's biologic companies. There isn't a single customer that we would call out as being overly impactful on destocking. It's several customers, which makes it more of a sector-wide trend that we're seeing and not just specific to a customer or customers.

Okay. And what -- looking back, now that we -- now we see that situation unfolds, what do you think drove the excess inventory levels, some of these customers build up in 2023? Was it concerns on supply chain or availability of products?

Yes. Part of it was driven by our own lead times that actually have pushed out over the last number of years. So that would have influenced how some customers were looking at it, what level of safety stocks they believe they needed to hold, I think the supply chain, again in of itself over the last number of years, influenced the level of stock that people needed and wanted to carry. I think that's shifting a little bit now as our lead times have come down. We've added more capacity. We're back to more normal levels of supply. And then when we look at our customers, are they also looking at their levels of safety stock at this point in time and now what's appropriate for them. So there are a number of factors. There's like working capital and inventory management in there also. So I don't think it's just one driver. I think there are a number of factors influencing.

Okay. You just touched on your own lead times getting better. Would you say that, that all the manufacturing and all the logistics, that's all been worked out and sort of back to pre-COVID levels? Or are there still any pockets where it's elevated?

It's -- for all intents and purposes, it's back to pre-COVID levels. We have seen, obviously, COVID itself and the pressure that put on our business has dissipated. We've added in capacity into certain areas of business, which are growth driven and primarily within the high-value product segment across 5 different manufacturing plants. And that's enabled us to bring those lead times down. And now it also enables us to respond to pickup in demand when that comes to allow us to maintain the lead times that we're currently experiencing. So it's not to drive lead times back up to 40, 50 weeks, which is something that we want to avoid.

Okay. And when you -- as you said, you reiterated the guide on a sales basis, organic sales basis in April. But in January and February, the revision was -- a lot of the revision to the guide was tied to that excess inventory. As you sit 4 months later into the year, is your time line for that inventory drawdown, unchanged? Do you still see that returning to normal by the end of the year?

Yes. Based on the information that we have and the indicators that we're getting, that would be the case. So we would expect to see things improve as we move through the year and quarter-over-quarter.

Okay. All right. Now one of the other bits you've been talking more and more about in recent conferences is Annex 1 regulatory rule in Europe that's gone on noise. Could you just provide a little more clarity where you would see the benefit from that? Is that incremental? Or is that different than all the regulatory changes you've seen in the past? And just sort of how it benefits you specifically?

So Annex 1 is a lot of focus on improving the quality of injectable drugs, especially on contamination and particulars, which means that you're going to be affecting the manufacturer, the fill finish, the final package. All of those things can contribute to improving the quality. We've had some customers, who have been looking at the proposed changes that were talked about. And we're proactive and starting to look at their processes, especially processes of older drugs that used legacy components, legacy processes, and have been the process -- are in the process of looking to upgrade. And we even cited one customer who's in that process right now. Since the Annex 1 has been put into place, we have seen a marked increase in the number of customers that are initiating projects to take a look at their products and their processes for upgrades. And so it was -- so we called that out on the April call, quite a big uptake. As we review all those different projects, it is interesting that each customer, each drug has got a specific case. And so there -- that's why they're starting a dialogue with us. So that they can understand on the component side what they could be doing, whether it be moving their legacy component from bulk to wash sterilized or maybe even moving that legacy component to a more modern formulation washed sterilized in vision or maybe even to coded. So it really is something that we're just at the start up right now. The -- it does play into our overall thesis in that the bar for quality continues to only move upward. The regulators are only moving that bar upward, and we think that there is -- and we have said in a while that there's a long runway for HVP conversion in our business.

So taking everything you just said, what is the time line we should be thinking about here? I mean, these are -- a lot of these products expecting, you're not enough flip a switch and change overnight. So how do we think about Annex 1 playing out?

So I think that -- again, because it's not just the component, it could very well also be a clean room. It could be a restricted access barrier and isolated that has to be put in. There are other pieces that have to go along with the ecosystem that there will be a component of time to go into it. So what we're doing is that we're preparing. We're working with those customers. We're making sure that we have the capacity so that as customers start to switch that we don't see any kind of slugs in our lead time like we had a couple of years ago. And so if you look at a lot of our capacity that we've been putting in and continue to put in, a lot of it is a focus on HVP processing.

So I think it's an important point that we don't expect a big bang event with this. It will layer in over time. It could take couple of years for people to convert. I think they're going to look at probably looking at new molecules coming to the market. What does it mean for those looking at existing platforms? How do they transition? So it is going to take time. But as Quintin said, we have been layering in capacity around specific processes to support the change. And that's something that we continuously evaluate to understand do we have that right capacity because we don't want to essentially commit to a customer and not be able to deliver on it and then to delay any implementation. So that's something that we work very closely with our customers on. But again, it is going to take time.

Okay. And Annex 1 is a Europe phenomenon, but you're a global company and your customers are global customers, right? So how do you -- how are they balancing that? Are they really going with 2 approaches where we're going to do this in Europe and this in the U.S.? Or are they just saying, the bar got moved here, so we might as well raise it year everywhere else?

Typically, we would see that it would be -- that they would switch to one, they're not -- we don't see them having 2 different solutions coming from us. So I think it will be a global platform change rather than specific to a region. It's the way we would read it now.

Okay. All right. And sort of taking that and folding it into the LRP and the long-term outlook for the business, there -- when we think about how West is positioned, you've got a couple of tailwinds. You've got the evolution of higher-value products. You've got tailwinds from GLP-1, which we haven't touched on yet. You've got Annex 1 rolling in, higher regulation headwinds, you've got destocking inventory thing that's happened the last couple of years, some volatility in pricing that sort of obscuring the underlying demand. Taking these 2 offsetting pieces, how do you -- sitting here, how do you reevaluate your LRP and your view of the underlying market growth?

Yes. We continue to look at our LRP with that 7% to 9% range. We're -- we don't see a need to really move off that at the moment, and we'll have to see how things materialize. It's really -- we're focusing on 3 different areas. We got -- there's volume growth based into that. There's a level of pricing. And then also, you've got mix shift. So there's 3 different drivers. And we believe that that's confident in is as we look into the long term and we just get through 2023, 2024.

Okay. And talking about in your prior answer on Annex 1, you touched a lot on capacity, ensuring you have no capacity and making sure that lead times and supply chain doesn't get messed up as volume comes back, you guided to $350 million of CapEx this year. You've had elevated CapEx, heavy CapEx for a number of years. How much of that is already sort of spoken for in terms of Annex 1 and things like that? Or how much incremental CapEx do you think you'll need going forward to position yourself for that?

Yes. I think if we look at the next number of years, I think once we get over layering at this level of capacity, and we're doing it both in our proprietary business, and we've had some incremental capacity adds within our contract manufacturing business, which will be coming online in 2025. We would expect that we would be coming back to the like kind of probably 6% to 7%, maybe 8% range on CapEx as a percent of revenues, which is typically what we were doing pre-COVID. But again, a lot of the vast majority of the CapEx that we've been layering in over the last number of years has really been driven by growth initiatives and future demand that we're seeing from customers and primarily concentrated in the high-value product space.

So as you layer that in ahead of future demand, sort of how much lead time do you need? How much visibility do you need? So let's say you're putting -- let's say you start digging today, what is that intended for? Is that intended to feed 2026 demand 2028?