West Pharmaceutical Services Inc (WST) — Q4 2021 Transcript

Thank you, Amanda. Good morning and welcome to West’s fourth quarter and full year 2021 conference call. We issued our financial results this morning, and the release has been posted in the Investors section on the company’s website located at westpharma.com. This morning, CEO Eric Green and CFO Bernard Birkett will review our financial results, provide an update on our business, and present an update on our financial outlook for the full year 2022. There is a slide presentation that accompanies today’s call, and a copy of that presentation is available in the Investors section of our website. On Slide 4 is our safe harbor statement. Statements made by the management on this call and in the accompanying presentation contain forward-looking statements within the meaning of U.S. federal securities law. These statements are based on our beliefs and assumptions, current expectations, estimates, and forecasts. The company’s future results are influenced by many factors beyond the control of the company. Actual results could differ materially from past results, as well as those expressed or implied in any forward-looking statement made here. Please refer to today’s press release, as well as any other disclosures made by the company regarding the risks to which it is subject, including our 10-K, 10-Q, and 8-K reports. During today’s call, management will make reference to non-GAAP financial measures, including organic sales growth, adjusted operating profit, adjusted operating profit margin, and adjusted diluted EPS. Reconciliations and limitations of the non-GAAP financial measures to the most comparable financial results prepared in conformity to GAAP are provided in this morning’s earnings release. I’ll now turn the call over to West’s CEO and President, Eric Green.

Thank you, Quintin, and good morning. And thanks for joining us today. We are excited to discuss our 2021 results and outlook for 2022. We will start on slide 5. West delivered a remarkable year of success. As I reflect on the year, three things stand out to me. First, our purpose. We serve to improve patient lives, and we understand the criticality of our role in the containment and delivery of life-saving and life-changing medicines, including the battle against COVID-19. Our team members have rallied together with great sense, strength, and resolve to meet the accelerated customer demand. I want to acknowledge this incredible effort and say thank you. Second, our proven market lead strategy: we have continued to meet shifting market and customer needs with unique value propositions across our business segments. This is evident in the continued strength of our financial performance in 2021. Lastly, trust. Customers trust West. As a global leader, customers come to us knowing that we will deliver superior value through our high-quality products and solutions. And we remain focused on delivering value to all our stakeholders on a sustainable basis and doing our part to support the healthcare industry. As highlighted on slide 6, 2021 was an exceptional year of sales and margin expansion driven by strong demand in our base business and accelerated demand for components associated with COVID-19 vaccines and therapeutics. We ended the year with 28% organic sales growth in the fourth quarter, and adjusted for COVID-related sales, our base business grew by mid-teens organically. Our proprietary product segment led the way with 37% organic sales growth. And all of this was fueled by high-value products, resulting in impressive growth and operating margin expansion for the quarter. Looking ahead, we are well-positioned with the right growth strategy around execute, innovate, and grow. Our committed order book is at an all-time high. We continue to realize the benefits of the globalization of our operating model and continue capital investments to support the increase in demand driven by the attractive end markets. Turning to slide 7. In addition to our financial momentum, West had several other notable accomplishments in 2021. We shipped over 45 billion components touching billions of patient lives. This was done with the continued safety of our team members as a top priority and the importance of ensuring the continuity of supply for our customers. As scientific and technical leaders in the industry, we continue to broaden insights with our expertise through West Knowledge Center, webinars, published articles, and technical presentations. We launched five product extensions that continue to bring additional value to our customers, and we donated over $2.5 million. But more importantly, over 3600 volunteer hours were donated by team members to help our local communities with the greatest needs. As we move to slide 8, we strive to be stewards of a sustainable future by factoring environmental considerations into every aspect of our business. In 2021, we expanded our ESG transparency reporting by aligning with a taskforce for climate-related financial disclosure recommendations. This includes reducing energy dependencies and lessening emission production through renewable and greener energy, developing more carbon-friendly products, and actively engaging with stakeholders to seek opportunities to have an impact on climate. Aligned with our focus on improving patient lives across the globe through our products, we remain strongly committed to creating a healthier environment with efforts that will have a positive impact on our communities and future generations. Turning to slide 9, and the recent announcement of our collaboration with Corning. As you look across biotech and pharma companies and their drug pipelines, there is a growing need to provide system solutions to support increasingly more sensitive and complex molecules. With that comes a changing and increasing regulatory environment that is setting high bar requirements for performance data on combination products at the system level. These regulatory changes are driving drug manufacturers to look to West to reduce risk by specifically specifying a system of packaging rather than individual components. We’re excited to have Corning as a key collaborator as we expand our HVP value proposition to lead the industry from components to a truly integrated system that couples elastomer and glass. In response to our customers, this exclusive supply and technology agreement with Corning includes significant investment in R&D and capital for installed manufacturing capacity to expand Corning’s Valor glass technology. By combining West industry-leading NovaPure components with Daikyo FluroTec coating technology and Corning’s Valor glass and velocity vials, the collaboration will enable new advanced pharmaceutical packaging solutions. We believe that an integrated system of elastomeric glass under a single drug master file is the next level of high-value products. Our initial focus is addressing the need for a complete systems offering, and in time, we will offer a broad range of systems from vials to prefilled syringes to cartridges. As we enter 2022, we are building on the positive momentum we generated in 2021. We are introducing full-year 2022 financial guidance that assumes approximately 10% organic sales led by strong HVP sales and another strong year of both gross and operating profit margin expansion well in excess of 100 basis points. This guidance includes a substantial acceleration in our R&D efforts as we enter this new era of integrated systems. With a robust book of committed orders, we see momentum in 2022 and continuing into 2023. As such, we expect to add more capital expansion plans for additional HVP capacity to stay ahead of our customers' demand. We expect these projects to be completed throughout the year and ready for 2023 production. Before I turn the call over to Bernard to review our financial results in detail, I want to revisit our long-term financial construct. For the past few years, we have set our long-term financial construct as any organic sales growth of 6% to 8% led by HVP sales and annual operating profit margin expansion of 100 basis points per year. Over the past five years, we’ve had an annual organic sales CAGR of 13% and annual operating profit margin expansion of 240 basis points per year. Five years ago, biologics was our smallest market unit. Today biologics is our largest market with customers from emerging biotech to large biopharma coming to West and our partner Daikyo, which is reinforced by our strong participation rate in recently approved new molecular entities in the U.S. and also in Europe. As we look to the future, we see continued demand growth for HVP products. As we launch a new level of HVP’s integrated systems, we’re updating our long-term construct to annual sales growth of 7% to 9%, and we continue to expect to expand operating margins by 100 basis points per year over the next few years. Now I will turn it over to our CFO, Bernard Birkett, who will provide more detail on our financial performance.

Thank you, Eric, and good morning. So, let’s review the numbers in more detail. First, let's look at Q4 2021 revenues and profits, where we saw continued strong sales and EPS growth led by strong revenue performance in each of our proprietary market units. I will take you through the margin growth we saw on the quarter, as well as some balance sheet takeaways. And finally, we will review our 2022 guidance. First up Q4, our financial results are summarized on slide 10, and the reconciliation of non-GAAP measures is described in slides 19 to 22. We recorded net sales of $730.8 million in the quarter, representing organic sales growth of 28.3%. COVID-related net revenues are estimated to have been approximately $124 million in the quarter. These net revenues include our assessment of components associated with vaccines, treatment, and diagnosis of COVID-19 patients, offset by lower sales to customers affected by lower volumes due to the pandemic. Looking at slide 11, proprietary product sales grew organically by 36.8% in the quarter. High-value products, which made up approximately 74% of proprietary product sales in the quarter, grew double digits and had solid momentum across all of our market units in Q4. Looking at the performance of the market units, the biologics market unit delivered strong double-digit growth led by Novapure and Westar components. The generics and pharma market units also experienced double-digit growth led by sales of FluroTec and Westar components. Contract manufacturing organic net sales declined by 2.1% in the fourth quarter, primarily driven by lower sales of healthcare-related medical devices. We continue to see improvement in gross profits. We recorded $300.6 million in gross profits, $89.5 million or 42.4% above Q4 of last year, and our gross profit margin of 41.1% reflects a 470 basis point expansion from the same period last year. We saw improvement in adjusted operating profits with $189.2 million recorded this quarter compared to $119.1 million in the same period last year, marking a 58.9% increase. Our adjusted operating profit margin of 25.9% was a 540 basis point increase from the same period last year. Finally, adjusted diluted EPS grew 52% for Q4, excluding stock-based compensation tax benefit of $0.6 in Q4. EPS grew by approximately 58%. So, let’s review the growth drivers in both revenue and profits. On slide 12, we show the contributions to sales growth in the quarter. Volume and mix contributions amounted to $153 million or 26.4 percentage points of growth, including approximately $78 million of incremental volume driven by COVID-19 related net demand. Sales price increases contributed $11.3 million or 1.9 percentage points of growth. Looking at margin performance, slide 13 shows our consolidated gross profit margin of 41.1% for Q4 2021, up from 36.4% in Q4 2020. Proprietary products' fourth quarter gross profit margin of 46.3% was 460 basis points above the margin achieved in the fourth quarter of 2020. The key drivers for the continued improvements in proprietary products' gross profit margin were favorable mix of product sold, driven by growth in high-value products, production efficiencies, sales price increases, partially offset by increased overhead costs, inclusive of compensation. Contract manufacturing's fourth quarter gross profit margin of 16.5% was 70 basis points below the margin achieved in the fourth quarter of 2020. The decrease in margin is largely attributed to increased raw material cost and a mix of products sold. Now let’s look at our balance sheet and review how we’ve done in terms of generating more cash. On slide 14, we have listed some key cash flow metrics. Operating cash flow was $584 million for the year, an increase of $111.5 million compared to the same period last year, a 23.6% increase. Operating cash flow in the period was adversely impacted by a working capital increase as well as an increase in tax payments. In 2021, we spent over $253 million on capital expenditures, a 45% increase compared to 2020. The majority of the incremental CapEx has been leveraged to increase our high-value product manufacturing capacity within our existing facilities. We expanded capacity at 13 existing sites, implementing 13 major facility modifications and over 400 pieces of equipment, all while keeping pace with the growing demand. We have continued to increase capacity at our HVP sites in the U.S., Germany, Ireland, and Singapore, and we have been able to leverage our existing asset base to support proprietary products manufacturing. For example, our Williamsport, Pennsylvania site, formerly a contract manufacturing site, will be transformed with over half its manufacturing capacity to support proprietary products with elastomer mixing and batch offline. This leverage is in close proximity to our HVP site at Jersey Shore. As we flex our global infrastructure with the phased capacity expansion, we are well-positioned for continued growth in 2022. Working capital of approximately $1.1 billion increased by $277.6 million from 2020, primarily due to higher accounts receivable from our increased sales, higher inventory levels, and an increase in our cash position. Our cash balance at December 31, $762.6 million, was $147.1 million higher than our December 2020 balance. The increase in cash is primarily due to our strong operating results in the period, offset by our share repurchase program and higher CapEx. Turning to guidance, slide 15 provides a high-level summary. Full-year 2022 net sales guidance will be in a range of $3.05 billion to $3.075 billion. There is an estimated headwind of $70 million based on current foreign exchange rates. We expect organic sales growth to be approximately 10%. This composition comprises mid-teen growth in our proprietary business, with the forecast including mid-teen growth in our base business and mid-teen growth in our net COVID-related revenues. For contract manufacturing, we are forecasting low-to-mid single-digit negative growth in 2022. We do expect contract manufacturing to return to growth in 2023. We expect our full-year 2022 reports of diluted EPS guidance to be in a range of $9.20 to $9.35, and our CapEx guidance is $380 million for the year. There are some key elements I want to bring your attention to as you review our guidance. Estimated FX headwinds on EPS had an impact of approximately $0.21 based on current foreign currency exchange rates, and our guidance excludes future tax benefits from stock-based compensation. To summarize the key takeaways for the fourth quarter, strong top-line growth in proprietary, gross profit margin improvement, growth in operating profit margin, growth in adjusted diluted EPS, and growth in operating cash flow deliver in line with our pillars of execute, innovate, and grow. I’d now like to turn the call back over to Eric.

Thank you, Bernard. To summarize, in Slide 16, the excellent financial performance reported today continues to reaffirm that our strategy is working. We have a strong base business, proven by our market-led approach to delivering unique value to our customers. Our global operations team is efficiently manufacturing and delivering products in this complex environment with a focus on service and quality. We’re continuing to accelerate capital spending across our operations to address current and anticipated future growth. We realize that our products are critical for healthcare across the globe, which is why we’re so dedicated to supporting patient health today and well into the future. So Wanda, we’re ready to take questions. Thank you.

Hi, good morning. Thank you for taking my question. Just a couple of points initially. So, can you remind us what the full-year COVID contribution number was for ‘21? And as you still look at the ‘22 guide, and just in general of the business, I mean are you capacity constrained on your non-COVID products? I've been paced to be. Is this a polite way of asking that as COVID sort of rolls off, are you going to be able to backfill that with non-COVID business, and then reach into the question of what does ‘23 look like?

Good morning, Derik. On the COVID number, it is $459 million for 2021. We would expect to see that grow in the mid-teen range within 2022. Regarding capacity, I’ll hand over to—yes?

Yes, thanks, Derik. On the capacity, you’re right. When we think about where we’re adding the capacity, it is really around HVP products, primarily NovaPure plungers and stoppers. If you consider the two areas of high growth that we’re experiencing, we anticipate continued growth around vaccines and our biologics portfolio, which would require and is consuming the additional capacity that we’re putting in place as we speak today. We have plans that we’ve created investments in 2020, and that has been put in place, ready for production as we speak. Additional capacity is coming on throughout this year and into early next year. So, it’s a combination of both, Derik.

But you do feel confident that you’ll be able to backfill. Is that—essentially, every question I’m getting from investors is like, are you and other companies that are supplying to the COVID vaccine market going to have this big gap in ‘23 as things roll off?

No, we will be able to utilize the existing equipment and the future equipment we’re installing right now. The approach we took on bringing customers toward the highest part of our growth in the portfolio is key for absorbing that as we go into 2023 and 2024 if the trajectory shifts around vaccinations.

Yes, and this is something that we communicated throughout 2020 and 2021. As we layer in this extra capacity, it’s not solely for COVID; it's for both core and COVID businesses. Even if there is a slight lag, it will be for a very short time based on the order book and the forecast we have. So, we’re relatively confident that we can use that capacity quickly as soon as it comes on board.

Great. I’ve got some more, but I’ll shut up and let somebody else ask. Thanks.

Great. Good morning, guys. Thanks for taking the question. Just on a more positive note, I'm encouraged by the CapEx expansion up to $380 million; it’s a pretty significant number and a good bump up from last year. To me, that demonstrates good confidence in your outlook. I also noticed you bumped up the long-term outlook by 100 basis points, which reflects that confidence. But I’m trying to figure out just this CapEx expansion. It sounds like it’s more non-COVID related base business stuff and is there also a big chunk of that related to Corning? Can you give us a little more visibility on Corning and how that ties in with what you mentioned about expansion and in R&D, which has been running about 2% a year?

Yes, a couple of things there. So, on the CapEx, some of that CapEx is still around COVID. A lot, which is rightly targeted around supporting the base business, is particularly focused on high-value products. Currently, about 70% of our CapEx is growth-based at this point. And on Corning, yes, we are making some investments around that, which we expect to be about $50 million CapEx in the year. We will see a step-up in R&D as well surrounding Corning, and that's all factored into the forecast.

In terms of COVID and I realize this question is somewhat repetitive, but it sounds like you certainly expect growth this year. Did you get a sense of what your customers see going out over the next few years? Obviously, there are many unknowns, but any insight on that? And as the therapeutics have evolved, have you seen any changes in packaging from the initial stages, or are customers looking more for your services and products? Can you give us any color on that?

Well, Larry, here’s what we’re seeing. Initially, we were providing solutions around vials, initially designed for multiple doses. We are now seeing a transition in lifecycle management as we speak. Beginning in 2022, it's evolving toward fewer doses per vial. This results in a different solution that we provide with more favorable economics on a unit basis, which is a net positive for West. The transition will take place, not perfectly within the calendar year but will span 2022 into 2023. Following that, Bernard mentioned some capital expenditures; it’s still leaning towards backfills, more toward prefilled syringes. So, our investments are aimed at those transitions as it's more of a one or two-year start for our customers. I hope that clarifies how the landscape is evolving over the next several years.

Yes. I appreciate that; that’s good insight. Just one last question if I may. Regarding price increases, you mentioned it was just below 2% for this quarter. I look at that in the light of the supply chain impacts and inflationary pressures. You guys are probably better positioned than most companies, frankly better than most in your industry. However, there are still inflationary trends, particularly in oil and resin. So, should we expect price increases to increase over time? Have you been incrementally increasing prices to offset some of these inflationary pressures?

We have the opportunity, based on agreements that are in place, to implement some price increases to offset inflationary pressures. That’s something we have actively pursued towards the end of 2021 and we expect to continue to see in 2022.

Okay, great. I appreciate it, thank you guys.

Okay.

Hi, thanks very much. Eric, I appreciate the update on the long-term growth construct. Can you just talk about how you think about longer-term CapEx around that same construct? Should we be thinking that CapEx as a percent of revenue might be declining after the big bullets in the last few years? Just how are you thinking about that number?

Yes, John, once we get through these interim bulks that we’re currently managing through, we do want to revert back to 6% to 7% on sales revenues as appropriate for that type of business. We consider above 30% of our CapEx to be maintenance—let’s call it 10 to 15% for our digital, and the balance is for growth. Thus, we believe that construct—while while this year is purely growth-focused—reflects an efficient leverage on the capital we are planning on deploying.

Yes. Just to add on that, John. In previous years, capital maintenance would take 40% to 50% of our CapEx budget. Now we’re seeing growth as the majority of the budget. As soon as the CapEx hits our facilities, it’s immediately translating into operations, and we’re reaping returns much quicker than previous investments, given their nature. We are responding to demand, and thus far capital allocation remains unchanged through 2020, 2021, and heading into 2022. It should normalize.

Got it, thank you. A follow-up, Eric, I think you mentioned early in the call that the order book was at an all-time level, which sounds good. Can you elaborate on that? As you think about biologics versus generics versus pharma, what does that order book tell you in terms of growth trajectory? Has the duration of your order book extended or is it typical today versus a year or two ago?

There are two dynamics happening. Regarding visibility beyond the four to five quarters, we’re now looking at almost a two-year horizon. It’s indeed increased. Part of our strategy involves working alongside supply chains to improve visibility further so we can level-load operations more efficiently to support customers effectively. Regarding the increase, the demand is primarily driven by three buckets: increased demand for vaccines, significant success with various drug launches for our clients, and core growth encompassing biologics, pharma, and generics. Overall, all areas are growing nicely, reinforcing our prior CapEx profile, targeting higher end products.

Hi, thanks. This may be a little repetitive based on the last answer, but I’ll ask anyways. I mean, there’s considerable participation rate. I’m just curious: Are you seeing a change in market share or just the market around biologics? You are talking about mid-teens growth hedged over this year. You just bumped up your long-term growth outlook. Is this the market in biologics, or are you taking share also with the growth in higher-value products?

Hi, Jacob. It’s actually all of the above. Our participation rate in biologics continues to be well north of 90%. I’m very pleased with our performance in 2021, particularly after VLA was approved, which enhanced our product configurations. In our small molecule area, we see ANDAs equal or slightly better than pre-COVID levels, which shows gradual improvement as we progress. The exciting new partnership regarding HVP elevates our leadership and introduces advanced technologies to the market that lessen our customers’ market entry risks.

Got it, that’s helpful. And maybe following up on de-risking the process. I think in December, the FDA put out some guidance on visible...that something could be a catalyst for you all or maybe it’s nothing. Just curious on that.

It helps us. Anytime there are higher-level quality requirements or regulatory changes, it places us—or our partner Daikyo—in a favorable position as our solutions can meet standards. Increased intensity in regulations leads us to favor a systems-based approach with Corning, aligning with our trajectory amid these rigorous regulatory changes.

Hi, thanks, good morning. Thanks for taking my question. I wanted to ask about your long-term growth construct on revenue, specifically. Could you talk about contributors and expectations for growth between proprietary products and contract manufacturing? I’m asking because contract manufacturing has fluctuated quite a bit. Are your contributors to expectations possibly different than originally?

Yes. The driver behind that is primarily our proprietary business more so than contract manufacturing. We’ve indicated some volatility based on contracts and the timing of new agreements. When we look at proprietary products, we are very optimistic given the growth in biologics driving results. We do still believe in small molecules delivering low-to-mid single-digit growth on the pharma side, and generics is projected to grow at a much higher single-digit rate. Overall, the strong growth opportunities in biologics give us confidence in raising our long-term expectations.

Excellent. So if I then stick on proprietary products: any insight on biologics leading a higher growth rate with the higher adoption of high-end high-value products? Is there underlying volume growth from a stronger pipeline in recent years? Do these elements contribute to the strength expected for next year and beyond?

It’s all of those factors contributing to the robust demand across market segments, evident in our growth guidance for proprietary products in mid-teens for 2022. It’s the result of several key drivers amplifying the expansion of the overall business.

Great. That’s helpful perspective. Thank you.

Thank you.

Thanks, Wanda. And thank you for joining us on today’s conference call. An online archive of the broadcast will be available on our website at westpharma.com in the investor section. Additionally, you may access a replay through Thursday, February 24th, by using the dialing numbers and conference ID provided at the end of today’s earnings release. That concludes this call. Have a nice day.