West Pharmaceutical Services, Inc.

Good day, and thank you for standing by. Welcome to West Pharmaceutical Services' first quarter 2024 earnings conference call. At this time, all participants are on a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1-1 on your telephone. You will then hear an automatic message advising your hand is raised. Please note that today's conference may be recorded. I will now hand the conference over to your speaker host, Mr. Quinton Lai, Vice President of Investor Relations. Please go ahead, sir.

Thank you, Olivia. Good morning, and welcome to West's first quarter 2024 conference call. We issued our financial results this morning, and the release has been posted in the investor section on the company's website located at westpharma.com. This morning, we will review our financial results provide an update on our business, and present an updated financial outlook for the full year 2024. There's a slide presentation that accompanies today's call, and a copy of that presentation is available on the investor section of our website. On slide four is our safe harbor statement. Statements made by 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 risk 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 now turn the call over to our CEO, Eric Green.

Thank you, Quentin. Good morning, everyone. Thanks for joining us today. We will start on slide five, where I'd like to cover a few topics. we will review Q1 performance. Second, we will provide an update on the markets that we serve as well as updates on our growth initiatives. And third, we will provide an update to our full year 2024 financial outlook. Now, turning to the financial results, we delivered a solid start to the year. During the quarter, we again saw growth in our top-tier HVP component, NovaPeer, and our HVP devices, such as SmartDOS. We also continued to see inventory management or destocking by our larger, mature customers that are working down their inventory closer to pre-pandemic levels. With that said, Q1 had a solid start due to favorable order timing of customer deliveries fulfilled in the quarter. I want to address the question that many of you are asking. Are we seeing an inflection in destocking? The short answer is not quite yet. Several customers are still working through their safety stock levels, and we still expect Q2 to have an impact from customer destocking. and customer order trends continue to indicate a stronger second half of 2024 with a return to more typical order patterns in Q4. Therefore, after a solid quarter, we maintain our full-year net sales guidance. Turning to slide six. we continue to have an active year of capital expansion projects that are increasing capacity to meet growing demand for both our proprietary products and contract manufacturing segments. In our proprietary product segment, we have expansion projects in several of our HVP components manufacturing sites, such as Jersey Shore, Kenston, Waterford, and Eschweiler. These projects will provide a combination of increased manufacturing capacity, especially HVP processing, awashing, sterilization, and envision, as well as bring a higher level of global standardization throughout our network. We believe that this favorably positions West to address anticipated growing demand for HVP components, from volume growth of legacy drugs from recently launched or to be launched drugs and potential conversions from legacy customers to higher levels of quality in response to the global regulatory changes. Last quarter, we mentioned one such regulatory change was the European Union GMP Annex I. We continue to emphasize that that adoption. Both timing and level of HPP will vary from customer to customer and from drug to drug. What we are seeing in Q1 is an acceleration of interest from customers as Annex 1 calls for higher quality, lower particulate, and more stabilized solutions. Earlier this month at the Interfex Conference in New York, Annex 1 was a key topic of discussion with customers as we highlighted our innovative approach and leading products of Westar Select and NovaPeer. Also, in the proprietary product segment, we're making progress with capacity expansion of our HVP devices, including smart dose, self-dose, and admin systems. For the near term, we're working to layer in capacity through productivity optimization programs. And for the longer term, we are adding capacity that incorporates automation to complement our manual processes. With our contract manufacturing, we continue to build out capacity at our Grand Rapids site and significant expansion at our Dublin facility, which are both in support of a customer's injection device platform. These expansions are critical to the overall volume growth that we continue to experience with growing demand for certain components associated with drugs for diabetes and obesity. Shifting to slide seven, we're maintaining our full year 2024 organic sales growth outlook of 2% to 3%. Our teams are actively engaged in working through our customers' inventory management, We expect improved growth along with stronger growth and operating margins in the second half of the year, with Q4 projected to be the strongest quarter. For the full year, we are maintaining general core cost discipline while reinvesting into new growth initiatives, as I just outlined. Now I'd like to turn the call over to Bernard. Bernard?

Thank you, Eric, and good morning. Let's review the numbers in more detail. We'll first look at Q1 2024 revenues and profits. Where as expected, we saw a low single-digit decrease in organic sales and a decline in operating profit and diluted EPS compared to the first quarter of 2023, given the current market dynamics. I will take you through the drivers impacting sales and margin in the quarter, as well as some balance sheet takeaways. And finally, we will provide an update to our 2024 guidance. First up, Q1. Our financial results are summarized on slide 8, and the reconciliation of non-US GAAP measures are described in slides 15 to 18. We recorded net sales of $695.4 million, representing an organic sales decline of 3%. Looking at slide 9, proprietary products organic net sales decreased 4% in the quarter. High-value products, which made up 72% of proprietary product sales in the quarter, declined by low single digits, primarily due to decreased sales from our Floritec products and Westar components. Looking at the performance of the market unit, the Biologics market unit delivered low single-digit growth led primarily by sales of Novacure. The former market unit saw a high single-digit decline, primarily due to a reduction in sales of InVision and standard components, while the generics market unit declined double digits, primarily due to decreased sales from our Westar and Floritech components. Our contract manufacturing segment experienced low single-digit net sales growth in the first quarter, primarily driven by an increase in sales of components associated with diagnostic devices. Our adjusted operating profit margin, 17.7%, was a 530 basis point decrease from the same period last year. Finally, adjusted diluted EPS declined 21.2% with Q1. Excluding stock-based compensation tax benefits, EPS decreased by approximately 23%. Now let's review the drivers in both our revenue and profit performance. On slide 10, we show the contributions to organic sales decline in the quarter. Sales price increases contributed $24.1 million at 3.4 percentage points of growth in the quarter, as did a foreign currency tailwind of approximately $3.4 million. More than offsetting price was a negative volume and mixed impact of $45.5 million, primarily due to lower sales volume caused by customer inventory management decisions in the period. Looking at margin performance, slide 11 shows our consolidated gross profit margin of 33.1% for Q1 2024, down from 37.9% in Q1 2023. Proprietary products first quarter gross profit margin of 37%, was 550 basis points lower than the margin achieved in the first quarter of 2023. The key drivers for the decline in proprietary products gross profit margin were lower sales volume and an unfavorable mix of products sold, partially offset by increased sales prices. Contract manufacturing first quarter gross profit margin of 17% was 60 basis points below the margin achieved in the first quarter of 2023. primarily due to inflationary labor costs and an unfavorable mix of products sold, partially offset by increased sales prices. Now let's look at our balance sheet and review how we've done in terms of generating cash for the business. On slide 12, we have listed some key cash flow metrics. Operating cash flow was $118.2 million for the three-month end of March 2024. a decrease of $19.9 million compared to the same period last year, a 14.4% decrease, primarily due to a decline in operating results. Our first quarter 2024 year-to-date capital spending was $19.6 million, $8.5 million higher than the same period last year. We continue to leverage our CapEx to increase both our high-value products and our contract manufacturing capacity. Working capital of approximately $1.04 billion at March 31, 2024 decreased by $220.1 million from December 31, 2023, primarily due to a reduction in our cash balance. Our cash balance at March 31, 2024 was $601.8 million, $252.1 million lower than our December 2023 balance. The decrease in cash is primarily due to $267 million of share repurchases and or capital expenditures offset by cash from operations. Turning to guidance, slide 7 provides a high-level summary. we are reaffirming a full-year 2024 net sales guidance in a range of $3 to $3.025 billion. There is an estimated full-year 2024 headwind of approximately $8 million based on current foreign exchange rates. We expect organic sales growth to be approximately 2% to 3% unchanged from prior guidance. We are raising our full year 2024 adjusted diluted EPS guidance to be in a range of $7.63 to $7.88 compared to a prior range of $7.50 to $7.75. Also, our CapEx guidance of $350 million for the year unchanged from prior guidance. There are some key elements I want to bring your attention to as you review our guidance. Full-year 2024 adjusted diluted EPS guidance range includes an estimated FX headwind of approximately 4 cents based on current foreign currency exchange rate, which is an increase from the prior guidance of 2 cents. The updated guidance also includes EPS of 15 cents associated with first quarter 2024 tax benefits from stock-based compensation. Our guidance excludes future tax benefits from stock-based compensation. I would now like to turn the call back over to Eric.

Thank you, Bernard. To summarize the slide 13, the solid financial performance and execution in Q1 continues to reaffirm our proven growth strategy, strong base business, and the unique value of our high-quality product offerings for customers. We look forward to building on this momentum as we move through the year and our team is steadfast in meeting the anticipated growth expectations as we make a positive impact on health care across the globe. Livia, we're ready to take questions. Thank you.

Certainly. Ladies and gentlemen, to ask a question, you will need to press star 1-1 on your telephone and wait for your name to be announced. To withdraw your question, simply press star 1-1 again. Please stand by while we compile the Canada roster. And our first question coming from the line of Medler with William Blair, your line is open.

Hi, good morning. Wanted to ask about, you referenced the pickup in the back half of the year, but more about the second quarter. You know, last call, you discussed sort of a flip to positive growth in the second quarter. And Eric, in your comments, it sounds like there hasn't been inflection on the destocking. So just wondering if we should still be thinking about positive organic growth in the second quarter or if things are now more weighted to the back half of the year?

Good morning, Matt. Thanks for the question. What we're seeing is that Q2 will be sequentially stronger than Q1, but we also see that as we go into Q3 and Q4 throughout the year. We did see some demand in the first half of this year that we were able to be able to fulfill through our manufacturing sites in Q1. That I would consider as timing in the first half of this year, but the buildup will be sequential quarter over quarter over the next four quarters. Bernard, do you want to add any more?

Yeah, just as Eric said, Matt, you know, sequentially it'll be up. There is an element of timing between Q1 and Q2. So, you know, some of those orders that we shipped out in Q1, you know, originally we would have earmarked in Q2. So we're seeing that, and we're also seeing the destocking continue into Q2.

Okay, then maybe let me go from very near term to higher level, which is that some peers have described that the supply chain disruptions and longer lead times during the pandemic created an opportunity for them perhaps to get into West customers where they didn't have access to before. And so just curious what your assessment is of your competitive positioning and perhaps more generally the industry's bias towards sole source or multi source arrangements moving forward and just kind of ask that in light of all the high value capacity you're adding. Thanks.

Yeah, Matt, over the pandemic, we actually worked with our customers to make sure that we were able to continue to supply and that there wasn't any stock out with any particular customer. So we were successful through the pandemic period of time. And we've been working on reducing the backlog and increasing their safety stock levels really back in 2022 and 2023. The way we see it is that we continue to be on the molecules that are in the marketplace. We are working with them as they adjust their schedules for future shipments to be able to continue to supply those products in the market, and it is based on a number of scripts that are being, injections being administered. But also more importantly is if we look at our current win rate or participation rate last year and going into this year, it is as strong as it's ever been. So our interactions with our customers remain very strong. We have a very strong position in the marketplace. And the issue around potential sole source is that what customers have gained confidence in is that we have multiple sites that can be able to support their product in the marketplace. So they're not dependent. on a particular site. And in that sense, we're able to provide them with a single product, multiple sites to be able to support their global supply chain.

Okay. Thank you.

Thanks, Matt.

Thank you. And our next question coming from the line of Jacob Johnson with Stevens. Yolanda, it's open.

Hey, thanks. Good morning. Maybe just on the quarter, If I look at revenue and EBIT kind of sequentially, they were down a similar amount. And so kind of the decremental margins were maybe a little bit greater here. I know there's probably a few moving pieces as it relates to capacity additions and mix, but can you just talk about why we didn't see maybe a little bit more leverage on the margin side of things given the revenue outperformance in the quarter?

Yeah, it's primarily around gross margin, and that's impacted by mix, and then the overall absorption in some of our plants impacted the margin that we saw in Q1, but it was actually ahead of where we had predicted it to be, which was a solid performance for us in the quarter.

Got it. Thanks for that, Bernard. And maybe a longer-term question. You know, a couple years ago, you all updated your LRP to 7 to 9. Since then, GLP-1s and Annex 1 have emerged or come to the forefront. I'm just curious if you think if either or both of those trends kind of change your thinking about your long-term or medium-term outlook.

Jacob, good morning. This is Eric. I would say at this point we do not want to adjust our long-term outlook. However, we are excited about working with our customers in both areas that you described. One is in the GLP-1 sector, which we would be able to support our customers both in the elastomer side, but also in our contract manufacturing to be able to support them on their delivery devices. And on the Annex 1, we feel really good about where we are and the discussions that are ongoing right now with our customers and the trends that we're seeing aligns well with how we've positioned our portfolio, all the way from, you think about the component specifications, all the way to the manufacturing design, container closure integrity, then you think about documentation services, the whole suite of requirements to make our customers successful as they transition and be ready for the annex one. So while we're very well positioned in both areas, it is about timing. And change can take time, and adoption can take time. So we would say that the long-term outlook construct is a range. But as an organization, we don't have a ceiling. I'll leave it like that.

Got it. Thanks for that, Eric, and thanks for taking the question. Thank you.

Thank you. And our next question coming from the line of Paul Knight with KeyBank. You're on your cell phone.

Hi, Eric. As I look at the numbers, would it be fair to say that within contract manufacturing and proprietary delivery systems, you need to build capacity and there seems to be a ceiling right there for you right now?

Yes, Paul. Yes, I would characterize as such. Probably more pronounced in contract manufacturing. We do have significant investments going on right now, both in Grand Rapids and Dublin. That will be validation will occur later this year, but most commercial revenues will be observed in 2021. 25 going forward. And then in the high-value product proprietary devices, there are some constraints that we have due to capacity, but that's being layered in as we speak. So as the timing throughout the year, you'll see even stronger throughput later on this year.

Which leaves, I guess, standard packaging the weakest without a fair assumption and what's in standard packaging to make that the weakest, if it is?

Well, let me rephrase that. I think the HPP components for us, most of the stocking that we've experienced earlier this year is around that category. However, that particular part of the portfolio will ramp up. quite very nicely sequentially throughout the year. So it is most of the, if you look at the Q1, the proprietary elastomer side, it really is due to destocking at this point in time. But very, very strong outlook towards the end of the year and very strong, obviously, beyond that.

Yeah, I think, Paul, on that, it's important to note that we don't anticipate any major mix shifts You know, there's still the growth opportunities around HVP and in the biologic space, and even in Q1 that continued to grow, and you could see, you know, the growth driven there by the growth in NovaPure. So from a mixed perspective, I think when you look at it in the whole, the areas, you know, are growing and have growth potential as we look out past 24.

around standard components and packaging and hvp you know the trajectory is the same that they are the growth drivers okay thank you thank you and our next question coming from the line of michael redskin with bank of america your line is open hey thanks for taking the question um i just have a couple quick follow-ups one i mean you talked about the

the cadence and the progression of revenues through the year. I want to focus a little bit more on the margin side of things. I think we previously looked for a little bit more of a jump from 1Q to 2Q on the gross margin on proprietary products and, you know, on operating margins as well. Is it fair to say that given your comments on, you know, timing of revenues between 1Q and 2Q, that the second quarter margins will be a little bit more subdued as well and it will be closer to the first quarter? And then I've got to follow up.

We expect margin improvements sequentially as we move through the year. And, you know, that hasn't changed since we spoke about it in February. So we would see, you know, gross and operating margins step up quarter over quarter. Okay.

All right. And then on the contribution of price versus volume and mix in the quarter, price was, you know, a little bit weaker than we had expected. Is that just a component of mix in some of the, you know, destocking you talked about? Or, you know, should we expect price to be a bigger contributor as you go through the year? Or is that three and a half level of Albright? Thanks.

Yeah, no, it's a great question. I mean, last year was a unique situation due to inflationary pressures. This year, I think we discussed in February that we're targeting between the 3% to 4% corridor on net price contribution, absent of any HVP makeshift. And so we started the year off in line with what we expect, 3% to 4%. All right, thank you. Great, thank you.

Thank you. And our next question coming from the line of Justin Bowers with Deutsche Bank. Your line is open.

Hi, good morning. Eric, earlier you talked about some of your customers returning to pre-pandemic safety stock levels. Do you have a sense on when that normalizes this year and what it means in terms of typical ordering patterns?

And so we're seeing some of that return in Q2 as we speak. But as I mentioned in the prepared remarks that we're still seeing some destocking occurring into Q2. And as we look at the order patterns in the second half of the year, and obviously, as you know, we're made to order, so we have purview to look out multiple quarters ahead of us. It is stronger. than it has been in a number of years if you normalize for COVID. So we feel good about the... When we talk about sequential growth on the revenue for the next several quarters, we feel very good based on the order patterns we're currently seeing today.

On the contract manufacturing side, last quarter you talked about some operational improvements, I think maybe in Arizona, but is that... Is that somewhat of a gating factor until you implement those and get the throughput through? Or can you maintain the same productivity levels while you're making those changes?

This would be within our high value product devices portfolio. It's a smaller piece of our overall business. There are some, as we make these improvements, there are some I guess, constraints as we continue to manufacture, but most of those are being resolved as we speak.

Yeah, and I think the productivity improvements that we're actually working on right now don't impact our current levels of production. And again, we would see a sequential improvement in the throughput around that business. So we're not looking at a step back there. No.

I appreciate the questions and sorry that the background noise. I got some guys on my roof.

No problem. Totally appreciate it. Thank you for the question. No problem.

Thank you. One moment for our next question. And our next question coming from the lineup, David Windley with Jefferies. Your line is open.

Thanks for taking my question. I was going to say, Justin, let us know if you need us to come rescue you. But thanks for taking the question. I was going to come back to the mix. I hope I don't confuse the situation further, but just trying to understand the original question, I guess Jacob's question about the decremental margin and the moving parts there. I understand revenue was lower overall and so you have absorption impacts from that. But NovaPure you call out as strong and we've identified that the margin contribution from that ought to be really, really high. And then it sounds like you have some other reasonably high margin contributors that are being destocked. And so I guess I wanted to make a plea for maybe a little bit more granularity so we could understand the moving parts there. And then how that progresses as you see the sequential improvement through the balance of the year, possibly? Thank you.

Yeah, David. So it was really, you know, in some of the other areas of high-value products where we saw some step back in Q1. But what we do expect to see as we progress through the year, you know, the volumes around that business to increase again sequentially. And, you know, that's when we talked about the destocking earlier on in the year. We were saying it was across, you know, all different parts of our business. So we would expect, you know, that HVP growth to, you know, accelerate as we move through the year and then the margin and that to be reflected in our margins. And also, you know, we'll get the pickup of incremental or increased throughput as we move through the year. I think, you know, Q1 was our lowest level of throughput and we're a high-volume business. so absorption does get impacted.

As a follow-up, in these areas of higher demand, GLP-1s being one of the previous call-outs that you responded to, it's increasingly apparent that the efforts of the sponsors to get those products ultimately to market are, you know, very multifactorial with so many different elements of the supply chain, you know, investing aggressively to bring up capacity, you all being an example of, you know, at least two different areas where you're investing. To what degree do you have, you know, dialogue with those clients visibility to understand you know you invest and you you know add Nova pure capacity and you add injection device capacity but fill finish capacity is a challenge for example and and and that could be a rate limiting step that you also need to anticipate relative to the order patterns like how are you able to do calculus around that thanks

Yeah, David, that's a good observation is that not just upstream but downstream we have to be aware of. We do have very strong, very long-term relationships with customers that are in this space. So those relations are very well established. We do interact with them about their demand profiles, min to max type of conversation for the various drugs. And so we're sensitive towards that. Obviously, we don't speak to any of those volumes of a customer. But the way to look at it is, so to your question, if there's bottlenecks somewhere else in the value chain to get these products into the market, we have to be aware and we try to work with our customers with that understanding. Our role is to make sure that we aren't the bottleneck. And so as you think about the Elastomer side of the business, a lot of those assets are fungible. So these lines are not exclusive. So if we have to make a high-value product plunger, we're able to do that in multiple high-value product facilities, and our customers can improve more than one site. When it comes to contract manufacturing, it's a little different. That's installed capacity and there's a theoretical maximum to it. And that is one of many suppliers in that space. So that is different. That's a very tailored business model for a customer or multiple customers. So that's how we are tackling this, Dave. So as we look at the investments, On the elastomer side, we feel really good about where we are with our capacity. We have been expanding capacity, so we're in a very good position. On the contract manufacturing site, we will, if and when awarded additional contracts, we will build out, expand, and ramp up production to peak volumes within one or two years. So that's pretty typical of the model that we have today.

It's very helpful. If I could just sneak the last one in. On the D-Stock, is it possible to size or quantify or comment to, is the impact of customer inventory management in 1Q the peak, and you expect that to wane, you know, still continue into 2Q, but wane as you continue through the year? Can you comment on that?

Well, I will say it will wane. Yes, it is. going to wane throughout, as you talked about, throughout the year. Okay. And that's supported by our confirmed orders as we think through the balance of 2024 and also the discussion we had about sequential growth quarter over quarter for the next four quarters. Got it. Thank you.

Thank you. And our next question coming from the line of, Larry Sola with CJS Securities.

Great. Thanks, guys. Just a few follow-ups. I guess just on the update, I know you mentioned Annex 1 and whatnot. Just any, you know, qualitative thoughts on, you know, that you can speak to, just conversations with customers on, you know, potential conversions of legacy products going forward, anything that you could, you know, speak to there? Sure.

Good morning, Larry. Thanks for the question. Yeah, we've been having a lot of active discussions. And as I mentioned at the recent conference that we attended in New York, that was clearly the number one discussion point. And it's interesting is that we're very well positioned to be able to support our customers as we kind of think about How do our customers get ready to be able to support and provide product within the regulations of Annex I? Now, the one comment I will make is that one of the clear indicators that the most interest is coming from the multinationals. I think originally there might have been thinking around just the European firms, but this clearly is a discussion at a multinational level to really simplify their own supply chains. And so that's encouraging. And again, it's not just for new drugs. It's really a heavy emphasis on the legacy portfolio. So that's about as much as I probably can give you without going too detailed, but these are active dialogue discussions that they will take time. It will depend on the customer. It will depend on the drug that they would like to transfer. But we're well positioned to have those discussions and then act on them. Right.

I appreciate that call. And just a question on R&D. I know I think R&D increased last year, I think, 16%, 17%. What's sort of the outlook this year? I know Q1 looks like it was only up a little bit year over year, but I know the quarters could jump around a little bit. Just Thoughts on R&D? Where's the lion's share of that increase going into? I know a lot of investment into corning, but is it going into a lot of different areas?

Yeah, Larry, as a percentage of revenues, we expect R&D to be pretty constant as we go through the year. Where is that money going? You know, a lot of that increases around integrated systems and how we're building that out. And again, it is a partnership with Corning and supporting that and developing that market.

Okay. And just lastly, on price, I think you had like a little over 3% increase you mentioned this quarter. Is that about, you know, that also could probably move around a little bit, but is that probably a good, you know, run rate you think for the full year?

Yes, Larry. Yes, that's correct. That's a good position to be in for us. Great.

Excellent. Thanks, guys. Appreciate it.

Thanks, Larry.

Thank you. And I see no further questions in the queue at this time. I'll turn the call back now over to Quintana for any closing remarks.

Thanks, Olivia. Thank you for joining us in today's conference call. An online archive of the broadcast will be available on our website at westfarmer.com in the Investors section. Additionally, you may access a replay for 30 days following this presentation by using the dial-in numbers and conference ID provided at the end of today's earnings release. That concludes the call. Have a nice day.

Ladies and gentlemen, that's the conference for today. Thank you for your participation. You may now disconnect.