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

My name is Luke Sergott. I cover Life Science Tools and Diagnostics here at Barclays. With [indiscernible] Eric Green, President and CEO of West Pharmaceuticals and our -- Pharmaceutical Services, sorry; and Bernard Birkett, the CFO and Chief Operating Officer. So thanks again for making it.

It's just the CFO.

Just the CFO? Oh, sorry. Maybe we have the wrong title. Why not take more titles, Bernie? Anyway.

So let's go through the quarter and kind of the dynamics that you guys saw, readjustment as a guide. You had some issues on the proprietary product side, on the -- some of the products there. So walk through the dynamics and really what caused the reset?

Okay. Well, let me, first of all, say thank you for inviting us to the Barclays Healthcare Conference. It's a very productive day, and I appreciate that. No, we ended 2024 in line with our expectations as we think about -- the 2024 was the year a lot of -- in our industry, a lot of destocking effect that occurred. We saw that persist in our biologics space, generics, and we saw in the pharmaceutical area started to dissipate as we went through 2024. So we ended the year in line with our expectations. We starting to see a stronger contribution of our HVP components, which is the thesis of the growth for West. And so as we moved into 2025, as we think about the growth algorithm, we guided to about 2% to 3% organic growth on the top. And the key driver of that growth is our HVP components going back to the mid- to high single digits, primarily driven by really 3 factors. One is biologics; second one is GLP-1 expansion; and number three is the regulatory changes in Europe with the Annex 1, which we are supporting. A number of customers on molecules are commercialized in the market to help them move up in HVP. So that will be elements to give us the mid- to high single digits of HVP. We're very pleased to see that we'll probably gradually increase throughout the year, we believe will get us well positioned as we move in the following year behind that. We also guided that our contract manufacturing business was looking at about low to mid-single-digit growth, primarily driven by the expansion that we made in our GLP-1 space, the investments made in 2025. We start seeing some of the lines coming online in the second half of 2024. But basically, Grand Rapids, Michigan and also in Dublin, we'll see the growth start to -- start coming in line in 2025 and throughout 2025 as we scale. We do have a customer that has -- we're going to be reducing or no longer produce an older generation of a continuous glucose monitoring device product that will have some headwind to that business. But we will manage through that in the space, the location facility and team that we have in place will be repurposed for other business with other clients to be able to support future growth as we go forward. The one area that actually was probably the most -- created the most headwind for us when we started creating the guidance and I'll let Bernard speak to this a little bit further is around a product in our wearables within drug delivery devices. It's what we call a wearable SmartDose that we just simply are scaling up in a manual process. We put additional capacity in 2024. As we go into 2025 based on demand where we are as the price point and where we are with the cost to produce a product is imbalanced. And we're -- we have a 3-point plan, really 2 key areas we're focused on. We are -- we have a sound journey on that product as we scale and continue to scale. There's many areas that we can leverage. One area that will take a little more time throughout 2025 is moving from a fully manual process to an automated process. We have a full line that has been commissioned -- will be commissioned in 2025, which allow us to get better efficiencies, throughput and better margins. The other areas continue to dialogue with our customer as they ramp to support them on their growth but also get better economics with our customer. Those conversations are ongoing. There's urgency to get this rectified, so we can update the community on where we are going forward. But those are the 2 drivers that we have around that product that created a headwind. When you think about margin, all the good margin that we're -- the operating margin expansion with HVP components been negated by a device area is what we're going to focus and fix. I don't know if you want to add any comments?

Yes. I just think the important point is that we are seeing that growth in our HVP like mid-single, high single-digit growth that we talked about on our last call that is starting to return. We're starting to see the margin expansion come along with that as we bridge back to our LRP. So that is really positive. We do have this short-term lower growth rate in our contract manufacturing business, which would be kind of low single-digit growth for 2025. And again, that's primarily in the first half of the year. But again, as Eric said, we're working to fill that capacity that's being vacated by one of our customers. And this is a normal transition that we would see in that type of business within Contract Manufacturing, and it's really resolving the issues that we have around SmartDose and the economics that we get from that platform and the drag that it's -- we're experiencing here in '25 with that.

Okay. And let's talk a little bit about the SmartDose and the device there. How's the pricing from among those key customers? There's only a few of them. And then I kind of want to talk about from the margin profile on that business. I mean, this is a HVP that was the whole part of the mix dynamic. Like why is the -- what is the margin? How much lower is this than your overall HVP margin from a gross margin? And like why is it -- why did it start so low?

Yes. I'll set this up is that when we started this development agreement years ago with our client, our customer, we had -- at this point, we didn't have the ability. We didn't have scale at that point in time. And therefore, the way that we set the agreement up was basically, I would say, wrong footed in regards to our price and our cost structure. And again, like I said, we are correcting this, but that's how -- it was a new area for us to get into and to scale, and it takes multiple years to get to where we are. The fortunate part is that we have product that is very well received by the end patients that we're being informed of. It is very important for our customer to continue to see the growth of their particular drug molecule in the market. And we're able to support them on, not just in the U.S. market, but in multiple geographies. So we are partnering with them, enable them to be able to grow. But we, again, we needed to address the price and also the cost structure, which I laid out earlier that we will address.

Okay. And then as you think about that ramping, what are some of the levers that you can pull? Is that as capacity ramps in general in value?

The biggest area, I mean, obviously, as we scale, we'll have better leverage on materials, but it really comes down to labor. And it comes down to -- instead of having one facility, we have two facilities that are doing manual manufacturing of these products -- this product. And by putting automation, it will allow us to fully automated process, allows us to reduce cost quite considerably by getting higher throughput, again, maintaining the high quality and also efficiencies to support the margin expansion.

And the automation wasn't put in place at the initial start of the product ramp just because of the development contract that you guys had?

We started off as a manual process in one facility. And you're right, the volumes were very much lower and the acceleration of the demand of the product for a customer required us to move quickly to double the capacity by -- in another facility. But we were not -- and then we started commissioning and planning out the fully automated line, knowing that the ramp is going to continue to probably accelerate. But that does take time to get installed, commissioned and validated before we can run finished products through there.

Yes, it makes sense [ out of ] timing. Got you. I'm going to turn the page here and go to the inventory destocking that plagued the entire bioprocessing and supply chain for the last few years. It seems like it's almost -- should be finished for you guys as be a little bit more. You talked a little bit about there's still some effects that you're seeing there on the generic side. Give us any type of visibility you have, update there on how you think about that kind of rolling off?

Yes. I think it's contemplated when we talk about the high value. Really, a lot of this concentrated around the high-value product components. We think about the biologic continues to persist in the first quarter of 2025. And then the generics is pretty much -- we think, believe or planning throughout 2025, it might be sooner. And as you know, in biologics, the components used in that space is our HVP portfolio and generics is roughly a little over half of our products or HVP in that area. That's contemplated when we say HVP components will grow mid- to high single digits in 2025, which is a material improvement from last year. So we're seeing the destocking starting to play through and visibility of orders, visibility of future demand planning over the next multiple quarters with our customers gives us that lens that we'll be building throughout the year and going into 2026. And our position in HVP components continues to be extremely strong. When we look at the new approvals, particularly in the biologics and biosimilars, our participation is extremely high, hasn't changed. It's roughly around 90%. And that's one big driver of this growth that we're going to see coming through. And obviously, after the destocking effect. The other two key drivers we talked about earlier was around GLP-1s and Annex 1, but all three are cumulative that allow us to get to strong growth as we have... Just a real recap. If you look at the last 5 years of HVP components, it was very strong in taking out devices and anything else. It's very -- it's strong double digits. It's close to double-digit growth. And that is the thesis of West's growth. And we think about the drivers for future growth are consistent, but what has been added to this, not incremental, but added to ensure that we get to the -- back to our financial construct is this regulatory change that's occurring in Europe. And we're seeing the projects and it will be materializing in 2025 will get us that assurance of that type of growth of -- for HVP components for -- to hit our financial construct.

Yes. And on Annex 1, we were sitting here last year, we were talking about the benefits and the tailwinds here. Talk about the conversion that you're seeing and kind of the momentum that you started to build now and you're talking about it kind of continuing through '25. What's taken so long for this to kind of play out because it's not a relatively new regulation?

Yes. So in our -- within primary containment, the sterility of -- ensuring sterility of the primary containment, that has been written in late -- in 2023. A number of these projects that we have with our customers commenced, let's say, in 2024. And it takes -- we're seeing on average between 12 to 24 months to really bring it into commercialization. So -- we're supporting our customers to taking standard material components within our elastomer business that has readily historically been providing in bulk format. And now with our customers, they're making a decision of do they build the infrastructure on the pharmaceutical washing, sterilization, vision inspection and potentially the finished packaging process. As we think about this, they're looking at the investment they have to make and then they look at working with us and at West, we can provide that service for them, which we have been doing, and that's been the thesis of HVP for a number of years. So these projects are very specific in certain molecules in market that might have a legacy formula with West that we're now putting it through these different processes. And we have to do the analytical testing, the documentation and the filing to support them to make this transition. So it does take time. We do believe this is a long journey. It's going to be multi-year impact for West and continue to drive conversion of current volume in our standard components in bulk format into some part of our HVP portfolio. And so it's incrementally positive from ASP and also from a margin perspective, but also supporting our customers and ensuring that they're meeting the regulatory requirements in Europe. The last driver of this is that a lot of our customers are not just looking at for product going into Europe and looking at how do you standardize across the globe. And so we see this as a net benefit with a considerable amount of our customers and products in the market today.

They'll eventually convert as well.

Yes.

I guess from a -- like where are we in the documentation portion, getting things ready and starting to actually drive that conversion of the product. Where are we in the step of the cycle? Is it something where you have to do this for each category? Or is it just something you could do bulk upfront and then we'll hit the switch?

Yes, each. Unfortunately, we had to do one at a time. We can do a parallel process, obviously, with multiple customers. We have over -- we mentioned we have over 200 projects in flight as we speak. A lot of them started in 2024 that continues to build. And we see roughly about half of them start materializing in some type of revenue contribution in 2025. So again, it does take time. But as we layer on these projects and move them to completion, we'll see the revenue start pulling through. We did say that we'll see incremental benefit in 2025 of this transition that's occurring with Annex 1, which we did not really see all that much in 2024.

Right.

I think one thing is important to understand, one is customer specific that it is each customer has a project. It's not us running projects and then going to a customer. We're working in partnership with our customers. And they really decide on when they convert and what they convert to. And so that is something we manage with them. So I remember back as we were talking about it here last year, again, we were saying it is a multiyear process, and it is going to build over time. So it's -- we don't believe it's like a J-curve or a hockey stick or anything like that. You are -- you have customers who are early adopters of changes. And then some take longer to make that change. And again, as to what extent they want to change as well, we'll be down to the customer. So there are many different permutations as to what can be offered here. And it really feeds into that our LRP growth over a number of years. It's not just a one and done.

Got it. And is it something with the customer specific? Is it something where they have -- I imagine if they have existing products, they're going to be -- there's a lot more inertia to switching than if you have new products coming on?

Yes. So essentially, what they're doing is converting existing business we have with them through -- that we're providing standard products. So it's really converting existing volumes. So we don't need volume growth essentially off that. It's existing business that we're adding HVP processes too. And then as Eric said, that increases the ASP and increases the margin and the return to us.

Yes. Got you. Let's jump into Contract Manufacturing in the last 1/3 of the talk. You guys exited 2 CGM contracts. There's not a lot of CGM players out there. Just kind of walk through the decision to do this. And how fungible is this kind of -- how fungible is this capacity within your CM business?

Yes. So in both cases, we've been working with a couple of customers over 10-plus years on older generation of CGM. The model that we have in contract manufacturing is that while we provide the facility, the infrastructure, the engineering, the talent to be able to install and scale and do mass manufacturing, our customers are paying in capital with their proprietary or their IPs of technology or automation that does the assembly of the product. And it is specific for a product. And in this case, we have a customer that has been -- we've been working with for a number of years, obviously. And they've been looking to the next generation or two generations to adopt in the marketplace. We will continue to support them on an older generation and that demand has kind of persisted for a little bit longer than we anticipated. So we typically see 7 to 10 years and potentially longer with these agreements, these contracts with our customers on Contract Manufacturing. So the asset is fungible in the sense that when they pull their technology out and they decide they no longer need that product for the market or they have a next generation that we're not going to participate on, it will pull the lines out of the facility. We'll repurpose the facility for the next business that we bring in. That's also going to be the case. And later in 2026, we received information of another customer that has decided to bring a lot of the production in-house of the next generation. We saw it in both cases, there's an element of both insourcing versus outsourcing. So in that case, that space will be repurposed later in 2026, going into 2027 for other customers that are highly interested in that space. The target customers that we have today are around pharmaceutical drug delivery. If you think about auto injectors, if you think about pens, that's a space that we're really focused on. And if you think about why did West not participate in the next generation, we just look at the economics and said that part is actually dilutive to the overall CM. And we want to stay where we are with our margin profile, with our returns, and that's why we've repurposed that space for a higher profitable business that will be coming down the road. CM business, while this is occurring, we are also ramping up on long-term agreements with the customers on GLP-1s, auto injectors, and particularly in the United States in our Grand Rapids facility, but also in Dublin. What's unique about Dublin is not only will we be doing the injection molding and the assembly of the auto-injectors, but we're also being asked by our customer to do the drug handling in this dedicated facility, which allows us to actually move downstream. This is not fill/finish. But this is the drug handling, bringing the drug material with contact with the auto-injector then going into the market. This is obviously to support our customers on their growth. It's -- we're creating value. We have know-how because we have a couple of projects that we have been working with other clients on a smaller scale. But we're really excited about this opportunity because the customer is pulling us into this direction, and we could have further expansions in other parts such as the United States to support our customers on drug handling. Better margin profile, it doesn't mean that we're going to flip the contract manufacturing business overnight, but it does reinforce our focus on margin value creation and see the margin expansion and also healthy returns on our investments.

So you talked about the GLP-1s and the CM business -- about like 40% of that overall business. So you're talking about building out capacity in the Dublin, Grand Rapids, the CGM contracts, you're repurposing those into higher margins and higher growth businesses, arguably opportunity more for GLP-1. So fast forward, like 2, 3, 5 years, depending on assuming that GLP-1s are the panacea of drugs that everybody expects them to be. Like is this going to be a majority of your business probably as we kind of train that out?

No, I think what you're going to see in Contract Manufacturing because we're -- obviously, we have several other type of delivery devices for other drug categories that we support in that business. So we'll continue to diversify that portfolio as such. We will support in certain cases of further GLP-1, but I wouldn't say it would be taking on a majority of CM long term. On the proprietary side, it's different. So we are very well positioned to build support all the GLP-1 drugs in the marketplace through our elastomeric components. And we have been entrenched with our customers for decades. We feel really comfortable where we are in that space. And it's a very, very high market share in the proprietary side. In Contract Manufacturing, I think the way to think about that is a derisk by having 1 of 4, 1 of 5 different suppliers using their technology to manufacture. So we would be in the neighborhood of 20%, 25% type market share for a client, which is pretty typical. But in the proprietary area, it's very different and better economics.

And on the proprietary side on the elastomer especially, there's been a fear that other competitors can come in lower cost. Talk about what you're seeing from that part of the market, new entrants or even just the pricing dynamic around there? I mean you guys assume like it's spec-ed in. Like how hard is that for them to switch?

It's difficult, but we're cognizant of the fact we -- every day, we continuously look at how do we improve the technology, how do we improve quality, how do we improve service. We have scale. And there's no doubt that West is the largest player in elastomer components in the industry by far. And our win rate or participation rate on new molecules supports that we are continuing to be at that high level of participation, particularly in biologics, still in small molecules and also in the generic space. What we are also cognizant is that are in the supply chain with COVID, there is a drive to make sure that they're not solely dependent on a player. So as you think about new approvals. And the question is, how do you primary and secondary. And we continue to be the primary like we have historically. But I think we have to be cognizant of the fact that competition wants to get in. And we don't believe in a cost play or a price play, we are still thinking about 1% or less of the cost of the drug molecule with our customers. We have to drive the service. We have to drive the quality and the technology. And as we stay in the forefront, we will -- we believe we can continue to be the leader in that particular space.

Quality and reliability is still the biggest driver.

It's the biggest driver. You think about it, it's, as I said, it's about 1% or less of the cost of drug molecule. But if we're not able to provide product that cause a major issue on drug availability in the marketplace. And we pride ourselves on -- even in COVID, we're able to deliver product to our customers on the core business, base business is why we supported the COVID fight with vaccines. So we have the scale, we have the capacity. There is a push towards HVP and this catalyst of not just some biologics and GLP-1s, but there is a catalyst around Annex 1, and the capacity we installed for COVID is fungible for this -- these initiatives and these growth drivers. So we'll repurpose, get better leverage and build -- support the growth for a number of years ahead, particularly around proprietary HVP components.

It feels like a transition here. I appreciate it.

Thank you. Appreciate your time.

Yes. Thank you.

All the best.

Thank you for attending.

Thank you.