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

Yes. We're really seeing it across our business. We talked a little bit in Q2 about [ NovaPure ] as well as West [indiscernible] seals. Obviously, moving up that chain, the Annex 1 is primarily finishing. So when we think about that at [ Envision ] inspection, pharmaceutical grade washing, sterilization, those types of activities which help come right off our manufacturing line and are really value-added, not only for our customers, but also improve the outcomes of the manufacturing side. So we're actually seeing very nice growth and positive mix from that standpoint. And that's really helping and you can see it in our margins. As HVP continues to grow, that helps lift our overall gross margin business because if you think about on a standard basis, our standard products are our core products, gross margins in the 20%, 25% range. Our HVP business is 50% to 60%, sometimes even higher than that.

So clearly, a lot of top line drivers have played, demand in a really strong place. Are you comfortable now that you have the production footprint and the supply chain sophistication to service that demand, like any bottlenecks we should be considering? Maybe just talk about that footprint you have today?

Yes. We've been really focused on the HVP footprint, and we've got 2 plants in Europe, 2 plants in the U.S. and then 1 in Singapore. So from a footprint standpoint, we actually kind of mirror the way that the pharmaceutical supply chain works, which is really helpful for our customers. As you know, last year, we had supply outstripping demand, and we've put a lot of effort into adding some additional labor, primarily in the molding of the units over the last, I would say, 6 quarter -- 6 months, excuse me, and feel like we're in a much better place from demand, meeting supply or supply meeting demand, excuse me. And one of the areas that we're continuing to focus on is continuing to invest for growth in our CapEx. We've talked about while CapEx has come down to about 6% to 8% of revenue this year. we're disproportionately investing behind our HVP business to ensure that we do have the capacity going forward. And so particularly in that finishing area, we do believe that we have enough molding capacity across our footprint to handle. Sometimes, we'll have to add some additional labor to get utilization there. But we do feel like we have the ability to flex capacity. And we kind of showed that through our cybersecurity incident that we were able to recover quite quickly.

One of the interesting things from the disclosures across the quarters, APAC has been really strong year-to-date, I think nearly 30% growth there. Could you -- what's driving that uptick? And how do you feel positioned competitively there versus kind of your U.S. and European footprint?

Yes. We feel really good about the performance there. To your point, I think we grew 29% organically in Q1, grew 27% in Q2. So it certainly is driving a lot of nice growth. And when you think about our revenue, just overall, it's about 10% of the total company. So I think we have a lot of opportunity to actually increase our penetration there. And I would say, competitively, we feel very good, particularly at the high end -- what's driving that today is a couple of things. One is GLP-1, the generic opportunities, our fastest-growing markets are China and India. To capture that, and we feel that we have -- we have very good participation rate on those GLP-1 opportunities, not only in those markets, but also -- many of those companies are actually selling products outside of those 2 markets as well. So we're seeing very nice growth there. And then I think on the biologics side, particularly in China, what you're seeing is an explosion of innovation happening. And so novel molecules. And so we have a very good -- and that's what we focus really is at the high end within China, which is where that plays. These would be barrier coated products. And what you're seeing is those new products that are being developed -- with these new molecules that are being developed, they're not just having eyes for selling those products in country or in China. They're actually looking to multinationals to partner with and bring those products into places like Europe and the U.S. And one of the ways they want to lower risk is actually having the same primary containment mechanisms that you would see in the U.S. And so that's where we think we're really well positioned to be able to continue to take advantage of that. This is one of the areas where I think we're just kind of scratching the surface as we think about the business going forward. And my prior -- my predecessing company had a big business in Asia as did [ Michelle Lagarde's ] business before. And so I think we've got some experience about how to make sure that we stay on top of that and actually maybe accelerate it even further.

And maybe for those investors new to the story, maybe just level set the participation rate that West has in Europe, U.S. and that market share because I think it's perhaps underappreciated at times.

Yes. If we look at our overall market share, I'll start there and then look at participation rate. we have roughly 70%, 75% of all elastomers in the world. And that participation rate is strongest in the U.S. and Europe. So it's slightly higher than that. But in Asia, maybe a little lower, but still very solid. And particularly on the high end around the biologics or biologics, as I mentioned before, our participation rate, which is really how many products that just got launched or approved have a West product on them. And we know this because they ask for access to our drug master file, it was greater than 95% or it was 95% in the U.S. in 2025. So if you think about our participation rate in the fastest-growing areas of medicine, right, is actually higher than our overall market share and that participation rate is pretty consistent across the globe. So it's a huge opportunity for us, big responsibility also to continue to drive that, but we feel very good about that. And it's one of the things that I think is perhaps underappreciated is the interaction and the technical expertise that our teams have when a pharmaceutical company, a biotech startup is looking for packaging. West is kind of viewed as the gold standard and that technical expertise of interaction between the drug the delivery mechanism and how to ensure the safety and efficacy of that that's a really important element. In many of these startups, they don't really have a whole lot of packaging expertise. So they'll look to companies like West to help them solve those important problems. And then as they move up the value chain -- or excuse me, throughout the development, once you are locked in, you're spec-ed into the regulatory dossier, it's very unlikely that people will change primary containment. So that creates a very strong competitive moat and a very sticky business. And so getting that participation rate upfront is really important for long-term growth opportunities.

And get to a lot less attention just given what's going on in the core business. But West Vantage, the mix shift here away from those CGMs in with more drug handling, you also added a lot of capacity through '23 and '24 here. So how does that capacity utilization look footprint today?

So for those who may not know, West Vantage is our contract manufacturing business, and it's roughly about 20% -- about 17% in Q2 of our revenues. And we've had a long history of producing pens as well as auto injectors across that business. One of the things that we have been looking to do is move up the value chain here in what we call drug handling. And so taking the manufacturing or the assembly of those pens and then bringing in the cartridge that is already filled with drug -- drug substance, testing it to ensure if it's the right drug substance and then putting it into a pen or an auto-injector for a finished good. We had built a facility in Dublin, and that is ramping very nicely. It is about a $20 million opportunity here this year. Most of that actually in Q3 and Q4, about $15 million of it but it's a $60-plus million program which will when fully ramped, which is probably in 2028. We're looking for more opportunities around that. So one of the things, if we look across our factory footprint in West Vantage, the utilization of the equipment is fairly high because you're kind of geared towards the units that are your produced. But we do have opportunities to expand and add more additional programs, not only in Dublin with the exit of our [ ADC ] business, which was a med tech business that we're wanting to move, to get out of and move into higher-value pharmaceutical products as well as here in the U.S. And so what drug handling also does to give you a perspective, our gross margins for our overall business today for West Vantage or mid- to high teens. West Vantage drug handling has the opportunity to be above 30% gross margin. So you can see the improvement expectations that we would have is that business ramps.

Any [ resent ] of how much of the West Vantage mix drug handling could become with time? Any rough numbers there?

Yes. Certainly, that is our key strategy going forward. And what I would say is -- so that is the strategic intent to expand that. I am not -- we've got to have more than one program to really drive that, but it will be a more and more significant portion going forward.

And then just on the gross margin more specifically, another standout, I think, for Q2, how much of that came from structural changes like price and mix relative to timing or broader volume leverage?

Yes, I'm glad you brought that up. One of the things that we really do have an opportunity is given our fixed base, when we actually drive volume through our plants, we do get a lot of volume leverage. And so the most of it has been volume leverage, particularly in our HVP plants, given the strong performance that we have. But we have seen better efficiency as well. So one of the things that we may mention in here is opportunities to expand our margins beyond just mix and volume leverage is just starting to show up and then certainly price plays a role as well. We're slightly ahead of our price realization expectations through the first half of the year, which is helping that across the board.

Maybe just a little more color on that midterm margin construct and how you're thinking about that just given the mix seems to be in a really volume leverage coming through, I think those investments starting to pay off now. So maybe just paint us a picture over the midterm here.

Yes. One of the things I think is probably maybe underappreciated a little bit about the opportunities that we have, particularly in our cost of sales is the margin expansion opportunities beyond the mix shift and the pricing opportunities. And if we think about it, I kind of bucket it into kind of 3 buckets. One is kind of midterm -- near term, midterm, long term. And in the near term, we're already actioning this with some of the activities that we did at the beginning of the year with the expansion capacity utilization and [indiscernible] taking some of the lessons learned there to improve our yields, taking it throughout the network to really drive capacity. That's driving margin expansion as well. In addition, we think we have an opportunity to be better at procurement and logistics to really drive down our raw material costs going forward. And that's probably in the 1 to 3 kind of year time frame based on the way the contracts work and so forth. And that will help drive that. And then in the medium term, we also have, I think, a big opportunity to kind of leverage automation in our factories. And so we've still got a fair amount of manual processes in factories and by increasing automation that will drive not only reliability but increased output and that will continue to drive. And then longer term, I do think there's an opportunity for network optimization. When you think about it, we have 26 sites, 5 sites make up half of our revenue, so the other 21 sites or the other half. And so I think over time, there's an opportunity to better leverage that. So when you think about the 100 basis points that we've talked about, we get a good head start just on mix. This has an opportunity from an aspirational standpoint, to even be better than that.

And it clearly didn't impact anything earlier in the year, but we saw energy prices again recently [ rise ] up. So I think you have offsets within contracts to help, so maybe just give us a little more color on what high energy prices means for West?

Yes. Obviously, we are impacted by oil in 2 ways. One is logistics. The other is kind of some of the raw materials on the rubber side and so forth. And we do have seen increased costs. We do have the ability to pass those through via surcharge where we were able to kind of offset those costs not at a margin it's not margin accretive or anything like that, but talk about -- be able to offset that. We've talked about roughly mid-single-digit impact for the year, and it's really just timing in the way that the costs come in through the system. But we're well positioned to be able to pass on the majority of that cost going forward. And then we're continuing to work some of these other areas to help offset as well in terms of better yields and so forth. So we think we're well positioned there to be able to manage that on a go-forward basis.

Maybe on capital allocation, we had the [ SmartDose 3.5 ] divestiture earlier this year. Zooming out, just how comfortable are you with the existing portfolio? And how should we think about appetite to expand inorganically the coming years. I have since maybe a bit more of a bullish M&A tone from you recently, but maybe just level set up.

Yes. When you look at our balance sheet, first of all, when you look at our cash flows, we've had very good cash flows. We're continuing to drive more and more free cash flow conversion and have a very good balance sheet right now. And I would argue that there's an opportunity to be more efficient with our balance sheet going forward. [ SmartDose ] is a perfect example. We had a product that was dilutive to our overall margins. It's in a better -- we made a transaction and it's better in better hands today than what we can do. And so that's actually benefiting our margins for the full year this year by 50 basis points. That's been built into our guidance. It's another 50 basis points next year as we just closed that in July. And we'll continue to be objective about our portfolio. We feel good about it where it is right now. But to your point, I do think that there's an opportunity to kind of leverage our strong balance sheet to look for ways to continue to expand our business. Certainly, we have a lot of opportunities organically, but I think organic -- or inorganic opportunities will continue to be evaluated and as we look forward. Could be a bigger and bigger role for the company.

Do you think packaging is a focus here or perhaps looking beyond that?

I think what we would want to do is to ensure that we leverage our core strengths, which is around the elastomer, the opportunity to provide more solutions or products to our customers. If you think about kind of the supply chain the pharmaceutical supply chain. There's a number of different players, a number of different touch points. It's very complex, and it's only getting more complex with the number of new therapeutic modalities that are happening and so forth. And so I think we've got a unique position because that the elastomer touching the drug is a critical component to ensuring safe and efficacious drugs going forward. So if we think that there could be an opportunity to solve more customer pain points going forward. I do think that, that would be an area of opportunity. I don't think on the flip side, getting more into kind of the West Vantage inorganically is something that we would be interested in. We want to do that more organically.

Got it. And then [ Michele ], obviously joined the CEO a couple of weeks back. Any early sense of where his priorities will be sitting near term and how those discussions have been together thus far?

Yes. I'll let him speak for himself. But what I could tell you is he's hitting the ground running. He obviously comes from a great company, great experience, knows our business very well as a customer of West knows the market inside and out. And I think one of the areas that he'll want to impress upon the company is certainly ensuring that we're delivering the best we can to customers. When I kind of gets back to that comment that I was just talking about before in terms of helping solve customer pain points. And so I would expect that to continue to be a focus. He's out on a listening tour himself, talking to customers, talking to our employees over in Europe, looking at some of our key sites and so forth. So I'm super excited to have him as part of the team. He's coming in at a great time. And I think with his experience and global scale, that will only accelerate the things that we've been doing here at West.

Amazing. I think that's what we have time for Bob. Thank you so much.

Thank you.