West Pharmaceutical Services Inc (WST) — Q1 2023 Transcript

Great. Thank you, Quintin, and good morning, everyone. Thanks for joining us today. We will start on Slide 5. On April 14, West turned 100 years old. This is a major milestone that we're very proud of. Over the course of our 100-year history, the West name has come to mean so much to so many people. I would like to recognize our founder, Herman O. West, and the past generations of leadership that have built West to who we are today. In addition, I want to especially thank our 10,000-plus team members who are motivated by our purpose of improving patient lives and making a difference in the communities in which we work and live. Moving to Slide 6. I am pleased to report that we delivered a solid first quarter. This was driven by overall organic sales growth of over 2%. Excluding COVID-19, our base organic sales grew high teens. Our end markets remain stable even in this uncertain macroeconomic environment. As expected, we saw a drop in COVID-19-related sales compared to last year. That said, our Biologics market unit, excluding COVID, again grew double digits, and we expect this trend to continue for the rest of the year. With a focus on reprioritization of longer lead time components, our Generics and Pharma market units delivered an especially strong quarter of double-digit organic growth. In addition, our Contract Manufacturing had solid growth while delivering components for injection-related devices. This overall performance is a result of our team members across the globe as they remain focused on our strategic initiative of execute, innovate and grow. The resiliency of the business continues to be a reflection of our team members, and I want to acknowledge these efforts and say thank you. Turning to Slide 7. In addition to our financial performance, there were several other significant accomplishments in our quarter. I would like to highlight a few. In February, we opened our new R&D lab in Radnor, Pennsylvania. This investment supports our capability enhancements while meeting the growing needs of customers in the changing regulatory environment across the globe. The lab supplied research will include containment and systems for advanced therapies and biomaterials, along with advanced design and engineering for drug delivery. In addition, the lab will also test and develop elastomer glass systems, and the work done here will support our future R&D ambitions for new containment and packaging solutions. Our product innovations have been recognized with several notable awards, including the Best Technologies Award at Interphex for our West Ready Pack with Corning's Valor ready-to-use vials. And as we continue to make tremendous strides in ESG, we have announced a stability partnership with the Philadelphia Eagles who are recognized as environmental stewards across all areas of their business. We look forward to sharing more detail on our ESG efforts in our corporate responsibility report to be published shortly. Shifting to Slide 8. A robust capital investments through expansions and optimizing productivity across our global operations remain on track. We continue to drive forward the expansion of additional HVP capacity with the anticipated growth of our customers' biologic portfolios and drug launches. This includes the installation and validation of new manufacturing equipment for HVP plungers and finishing capabilities, which will continue to come online throughout 2023 and into 2024. Moving to Slide 9. We are reiterating our full year 2023 organic sales growth outlook of 3% to 4% and are raising our 2023 financial outlook for overall net sales and adjusted diluted EPS. While Bernard will go over more details in his remarks, I want to make a few high-level comments. We continue to see a decline in overall COVID-19 sales and now expect $60 million for the full year 2023 instead of $85 million. Even with this change, we are reaffirming full year 2023 overall organic sales guidance. We continue to expect mid-teens Proprietary Products base organic sales growth for the year. Contract Manufacturing is now expected to be double-digit growth compared to prior high single-digit outlook as we expect to see continued demand for certain injection devices as seen in Q1. Now I'll turn the call over to Bernard. Bernard?

Thank you, Eric, and good morning. We'll first discuss the revenues and profits for Q1 2023, where we experienced low single-digit organic sales growth alongside a decline in operating profit and diluted earnings per share compared to the first quarter of 2022. I will outline the factors affecting sales and margin for the quarter, as well as some takeaways regarding our balance sheet. Lastly, we will present an update to our 2023 guidance. Starting with Q1, our financial results are summarized and can be found on Slide 10, with the reconciliation of non-U.S. GAAP measures detailed in Slides 17 to 20. We recorded net sales of $716.6 million, indicating organic sales growth of 2.3%. COVID-related revenues are estimated to have reached about $23 million in the quarter, which is an approximate reduction of $88 million compared to the previous year. The revenues from 2022 included our assessment of components linked to vaccines, treatments, and diagnoses for COVID-19 patients, but were offset by lower sales to customers experiencing reduced volumes due to the pandemic. According to Slide 11, organic net sales for Proprietary Products remained flat during the quarter. High-value products, which accounted for over 70% of Proprietary Product sales, saw a low single-digit decline tied to the fall in COVID-related revenues. In terms of market unit performance, the Generics market unit showed high double-digit growth fueled by sales of Westar components, while the Pharma market unit recorded low double-digit growth driven by Envision and Westar components as well as Admin Systems. Conversely, the Biologics market unit faced a double-digit decline due to decreased sales related to the COVID-19 vaccine. Our Contract Manufacturing segment achieved double-digit net sales growth in the first quarter, primarily due to increased sales of components for injection-related devices. Our adjusted operating profit margin was 23%, down 340 basis points from the same period the previous year. Adjusted diluted earnings per share also fell by 13.9% for Q1, and when excluding stock-based compensation tax benefits, EPS decreased by about 16.1%. Now, let's examine the factors that influenced both our revenue and profit performance. Slide 12 highlights the contributions to organic sales growth for the quarter. Sales price increases contributed $38 million, or 5.3 percentage points to growth. This was offset by a negative mix impact of $21.3 million, mainly due to reduced demand related to COVID-19 and a foreign currency headwind estimated at approximately $20.1 million. Moving on to margin performance, Slide 13 shows our consolidated gross profit margin of 37.9% for Q1 2023, which is down from 39.5% in Q1 2022. The gross profit margin for Proprietary Products in the first quarter was 42.5%, reflecting a decrease of 90 basis points from the same period last year. The decline in Proprietary Products gross profit margin was primarily due to an unfavorable mix stemming from decreased sales related to COVID-19 vaccines and ongoing inflationary pressures on planned costs, including labor, raw materials, and overheads. Partially mitigating these factors were sales price increases and production efficiencies. The gross profit margin for Contract Manufacturing in the first quarter was 17.6%, a decrease of 250 basis points compared to the first quarter of 2022, largely due to the mix of products sold. Now let's review our balance sheet and evaluate our cash generation performance. Slide 14 lists some key cash flow metrics. Operating cash flow for the three months ended March 2023 was $138.1 million, representing a decrease of $13.1 million, or 8.7%, compared to the same period last year, mainly attributed to a decline in operating results. Our capital spending in Q1 of 2023 amounted to $82.1 million, which is $16.3 million higher than the same period last year. We continue to utilize our capital expenditures to enhance our high-value product manufacturing capacity at our current facilities across the U.S., Germany, Ireland, and Singapore. As of March 31, 2023, our working capital of approximately $1.4 billion remained stable since December 31, 2022. Our cash balance on March 31 was $886.3 million, down $8 million from December 2022, primarily due to our share repurchase program and increased capital expenditures, despite cash flow from operations for the first quarter. Turning to guidance, Slide 9 offers a summary. We are revising our full-year 2023 net sales guidance and now expect net sales to range between $2.965 billion to $2.99 billion, which is an increase from our previous range of $2.935 billion to $2.96 billion. There is a projected full-year 2023 benefit of $15 million based on current foreign exchange rates, whereas prior guidance anticipated a $30 million headwind. We maintain our expectation for organic sales growth to be around 3% to 4%, consistent with prior guidance. We now expect our full-year 2023 adjusted diluted EPS to fall between $7.50 and $7.65, a rise from our previous forecast of $7.25 to $7.40. Our capital expenditures guidance remains unchanged at $350 million for the year. I want to highlight some important aspects regarding our guidance. We anticipate total COVID-19-related sales for the year to approximate $60 million, down from earlier guidance of about $85 million. The net sales guidance also reflects an $8 million reduction from an expected divestiture of a European facility that produced standard Proprietary Product components. The adjusted diluted EPS guidance range incorporates an estimated foreign exchange advantage of approximately $0.02 based on current currency exchange rates, contrasting with prior guidance of a $0.11 headwind. Additionally, the updated guidance includes EPS of $0.15 linked to the tax benefits from stock-based compensation realized in the first quarter of 2023. Our guidance does not account for potential future tax benefits from stock-based compensation. I would now like to turn the call back over to Eric.

Thank you, Bernard. To summarize, on Slide 15, the solid financial performance and execution in Q1 continues to reaffirm we have a strong base business and are delivering unique value to our customers. While there may be instability in some small cash-dependent biotechs, these customers are not a substantial portion of our business. Our end markets remain stable, and there continues to be a promising pipeline of new drugs that could have meaningful launches and/or expansions over the next few years, which means more HVP sales opportunities for West. Our global operations team is efficiently manufacturing and delivering products in this complex environment with a focus on service and quality. And we're continuing to progress capital spending across our operations to meet current and anticipated future growth. With great pride, we realize this criticality of our products for health care across the globe, which is why our purpose to improve patient lives propels us each and every day. Norma, we're ready to take questions. Thank you.

Congrats on a strong start to the year. Eric, I have a quick question about the quarter and a broader perspective. There seems to be an acceleration in core growth, as you mentioned mid-teens to high-teens growth this quarter in Proprietary Products, and your guidance suggests similar mid- to high-teens growth for the year. It appears to be a shift away from COVID impacts for your company. Have your customers also experienced this shift, with less emphasis on co-treatments and a return to their core focus? I'm trying to categorize the factors driving this growth acceleration, considering the waning COVID effects, as well as the growth in NovaPure and other high-value products, alongside the overall growth in Biologics. I'm looking to understand how these three drivers align.

Thank you, Larry. As COVID demand decreases, we have been able to realign our long lead items with market expectations. This has resulted in strong growth in both the Pharma and Generics market units, which is significantly higher than what market volume demand would suggest. The growth in Generics is largely due to the adjustments in long lead times. We've also seen improved performance in our Contract Manufacturing, thanks to targeted investments that are starting to yield benefits, leading us to adjust our full-year outlook. I'm proud of our ongoing success in Biologics, not only with current drugs on the market but also with new drug launches, and our participation rate remains very high. While the reduction in COVID-related activities does affect our overall numbers, we aim to be more transparent about our core business. Overall, we are pleased with our execution and have made a strong start to the year.

Regarding capital projects and expansion plans, it seems that you have more than doubled your capacity over the past few years. As you look ahead to 2024, do you anticipate a slowdown or pause in your expansion efforts? How do you view your long-term plans beyond the next 12 months?

Yes, Larry, you're correct, we made significant capital investments over the past few years. One was aimed at supporting vaccine production during the pandemic. Fortunately, our team focused on providing our customers with high-value products. This equipment is versatile, and we are still utilizing it for growth in our core business, especially in the Biologics sector. We are also continuing to invest more capital. Currently, we are shifting some of our focus from vial configurations to prefilled syringes, specifically our plunger manufacturing capabilities, which will be operational this year and into 2024. This decision is driven by the demand we currently see and expect in the coming years. We will keep investing in capital as long as our growth profile remains strong. However, you're right, Larry, we first explore how to better utilize our existing assets and enhance efficiencies through higher automation before making additional investments. This is a daily consideration in our capital investment strategy. In summary, our continued investments are a result of business growth exceeding our expectations.

Got it. Lastly, I have a quick question for Bernard. The gross margin for Proprietary Products is down a bit, around 90 basis points year-over-year, but it absorbed about a $90 million drop in COVID sales, correct? I understand you may not disclose the exact quarterly figures, but I’m trying to gauge if moving forward, most of the benefits from COVID have already been factored in. Should we consider this current gross margin for Proprietary Products as a solid baseline, with the potential for some growth?

Regarding COVID, we experienced a significant decrease, going from $88 million in Q1 2022 to about $23 million this quarter. However, we have been focused on improving efficiency within our plants and gaining a better understanding of our cost structure. As we progressed through 2022, we began implementing changes, and we are starting to see positive effects. Additionally, we have managed to secure pricing that exceeds our typical range by more than 5%, which is aiding our margins and helping to counteract some inflationary pressures. Overall, this marks a solid start to the year. While there are various factors at play due to the macro environment, we remain confident in our ability to meet our guidance.

Eric, can you tell me if Michigan is now online regarding the CapEx side? Also, when you deploy this CapEx, when can we expect it to start generating revenue? Is it typically a 1-year or 2-year delay? Lastly, how do you benefit from the growth in GLP-1s?

Thank you, Paul. We're in a strong position regarding capital investments. Once we install and validate our systems, we see revenue come in quickly. Grand Rapids, Michigan, is one of our manufacturing locations, and when the production lines are ready, we'll activate them to meet demand. This trend is consistent across both proprietary products and our current market environment. Historically, we've made good investments, but some greenfield projects have taken longer to reach full capacity. Today, our investments are focused on meeting near-term demand, and in some cases, we're working to catch up. Regarding GLP-1, there is an interesting dynamic developing. Similar to our involvement with vaccines during the pandemic, we're engaged in the GLP-1 space with multiple customers and components, both in proprietary products and contract manufacturing for injectable devices. We're seeing strong demand in this area. While we don't disclose specific drugs or customers, we are investing particularly in plungers and auto-injectors within contract manufacturing. This is evident in both product lines as we speak.

And then the last question would be for Bernard. Bernard, what is your implied operating margin or guidance for the year?

Approximately 23%. And just on Larry's question, I just want to clarify one thing. The difference is on the COVID revenue between Q1 2023 and 2022 is $88 million. Just to clarify that the drop was $88 million.

For the space more broadly, the destocking has been an issue. And obviously, that's further upstream and not something that's really attractive for your business. But just on the subject to visibility, could you maybe speak to your visibility into customer demand right now, particularly around HVP, and maybe how that compares to your historical visibility over the last 3 to 5 years or so?

Before COVID, we were continuously enhancing our ability to understand customer demand in the market. We continued to develop this capability during the COVID period, which introduced some volatility. However, we are now back in an environment where we have improved visibility. As we focus on make-to-order processes, our customers are providing us with clearer insights into their demands for the upcoming quarters, allowing us to plan our global operations to support them with both existing drugs and new launches. We are seeing some movements in stock or working capital in certain segments of the business, which we consider when making our full-year forecasts or guidance. There are specific areas, particularly in our non-high-value product segment, that may experience more volatility. In contrast, for high-value products, we need to sustain our capital investments to stay ahead rather than just maintaining our current position. Currently, demand exceeds our available capacity. While we have improved visibility, it is not uniform across our entire portfolio, but we are adapting effectively.

Okay. Regarding the decommissioning of a plant in Europe and the investment in HVP capacity, could you provide insight on the current state of your order book and the expectations for the next 6 to 12 months compared to 3 to 5 years ago? Also, you mentioned participating in GLP-1s on the plunger side. Are these the NovaPure plungers you are referring to?

Well, Matt, I have a couple of points to address. Firstly, you're correct about the decommissioning of the plant, which was focused on a single product for a single customer. We're pleased with how that process is unfolding, as it was a standard product that didn't align with our growth strategy. Consequently, we made the decision, along with our customer and another party, to ensure that production can continue for those products but under different management. In terms of our order book, our growth profile is primarily driven by Biologics, and we are currently experiencing significant growth in Generics and Pharma, which we expect to see continue throughout 2023. However, looking at the long-term future, our focus will be on biologics across various therapeutic categories, particularly in the higher segment of our high-value products. Specifically regarding plungers, we offer a variety within the high-value product range, from FluroTec to NovaPure, depending on customer requirements. Overall, while our order book remains strong, the highlighted portion is more aligned with high-value products, especially at the higher end.

Maybe first, just sticking on the GLP-1 topic. And as it relates to contract manufacturing, I think that's a business that at times kind of the work you do with customers can vary year-to-year. Obviously, strong start to the year. You're increasing expectations there. Is this something that is kind of sustainable growth for you all? Or is there something about 2023 that maybe we shouldn't carry this forward into 2024 and beyond?

Yes, Jacob. Typically, the growth rate in contract manufacturing is around mid-single digits within our longer-term construct. Last year, we had declines in the Contract Manufacturing business, and now we're seeing a bit of a rebound. So if I'm looking out past 2023, it will be kind of more the mid-single, high single-digit growth rate.

Okay. I wanted to clarify a few points regarding the outlook for this year. If I'm correct, you mentioned mid-teens growth in proprietary products excluding COVID, but I believe it was in the high teens during the last call. Additionally, you indicated 23% operating margins, which were 23% to 24% last quarter. Is this related to the stronger growth in Contract Manufacturing for the year? Could you elaborate on that?

Yes. The operating margin is partly influenced by Contract Manufacturing, along with a decrease in the expected COVID-related business. These are the main factors contributing to the change.

On the revenue side, when we discuss the proprietary outlook, it remains consistent with the February COVID guidance without COVID. All three units are projected to perform strongly throughout the year and show consistent performance in that area.

A couple of questions. Is there a good rule of thumb to think about your CapEx in terms of revenue generation? For every dollar you spend in CapEx, it can generate X amount of revenues. I'm just trying to think about future opportunities and just sort of thinking about all the spend and how West will build it out.

Yes. We haven't communicated that in the past. What we have communicated is that a larger portion of our capital expenditures over the past several years has been aimed at growth, particularly within high-value products. Therefore, the investment in capital expenditures is contributing to both revenue improvement and enhancing our operating margin.

So moving on to the mix shift, which has clearly accelerated lately. When considering your forward model, does the margin seem more like 150 basis points? Or are you still expecting 100 basis points for your operational margin expansion on an annual basis, considering the mix?

Yes, Derik, I'm not going to provide a specific number, but we have indicated that we aim for a margin expansion of over 100 basis points year-over-year for several years. As an organization, we are focused on how we can surpass that target. With the advancements in automation and the ongoing changes in our product mix, particularly in Biologics, our recent participation in this area has been exceptionally strong, and I take great pride in that. We are committed to achieving the 100-plus basis points in operating margin, but we also see opportunities to be even more aggressive in our approach.

Great. And just one more. I'm thinking about some of the newer drug opportunities. There’s a lot of interest in discussions about GLPs. You've been building capacity for a while, unlike COVID which emerged suddenly. You've known there were trials coming. So I'm curious about what we need to see in terms of GLP trends in the market and prescription trends to understand what the potential upside could be for your business. It's clear that something is already integrated; this isn't a completely new market for you. I'm interested in how you view this market as it evolves.

There are 2 areas. One area, specifically around our product portfolio, unlike what we've seen in other types of configurations like vial configuration, we can get multiple doses per vial. In this particular area is single-dose, right? And so as prefilled syringes continue to grow, we're going to need to continue to invest in plungers. And that's what we're seeing, and that's where our areas of investments are going. And we'll continue to respond to our customers' forecasted demand. And again, it's more than just one customer, it's multiple customers. So that's one. It's around the conversations with our customers planning ahead, not on just existing solutions in the market, but future drug launches that they're planning, that's where our conversation is. If we're waiting to the commercialization of them, we were today and they're today. So that's one area. On the Contract Manufacturing side, a little different where, as you know, we've been very clear about this, that part of our business, unlike our proprietary business where if you're on the molecule, you're pretty much the main provider of those components. In the Contract Manufacturing, our customers tend to diversify with multiple companies to be able to produce those, i.e., auto-injectors. So while that volume goes up, I wouldn't say it's 1 to 1 for us. It's clear in the proprietary side, but not as much on the Contract Manufacturing side. So hopefully, it gives you a little bit of kind of visibility and particularly around the GLP-1 specific area.

So I think it sounds like you said that contract manufacturing that, that could grow from mid-single digits, I think, was the previous long-term target there to mid-single to high single digits. Is that increase over the long term, is that all GLP-1s? Or are there other drivers there that would be driving that upside?

It's a combination of various customers and different products. GLP is one area contributing to growth, but not the only one. We have been making investments in contract manufacturing since late last year and continuing into this year. We will keep making these investments as needed with our customers. Part of the growth is indeed related to GLP-1.

I believe the company has indicated a long-term revenue target in the high single-digit range, and now we are seeing strong trends across the portfolio, including some increases in Contract Manufacturing. What are your thoughts on how that revenue growth might appear beyond 2023?

I believe we are maintaining our focus on achieving 7% to 9% organic sales growth over the long term. We are excited about our involvement with GLP-1 as it develops. Our organization is well-positioned to assist our customers across various areas, particularly through proprietary components, which have a stronger economic profile for us. While we do have a significant reliance on the proprietary side in our Contract Manufacturing efforts, the anticipated 7% to 9% organic growth is not exclusively dependent on that category. We have a number of customers with various product launches and the ongoing uptake of existing drugs in the market that we need to continue to support. Our growth will come from a combination of several drugs, a diverse customer base, and multiple therapy classes. While we are involved in GLP-1, it’s important to note that the expansion of this business is well-diversified.