West Pharmaceutical Services, Inc. (NYSE:WST) Q4 2022 Earnings Call Transcript

West Pharmaceutical Services, Inc. (NYSE:WST) Q4 2022 Earnings Call Transcript February 16, 2023

Operator: Good day, and thank you for standing by. Welcome to West Pharmaceutical Services Fourth Quarter 2022 Earnings Conference Call. . I would now like to hand the conference over to your speaker today, Quintin Lai, Vice President, Investor Relations. Please go ahead.

Quintin Lai: Thank you, Shannon. Good morning, and welcome to West’s Fourth Quarter and Full Year 2022 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, Eric Green and 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 2023. There’s a slide presentation that accompanies today’s call, and a copy of that presentation is available on the Investors section of our website. On Slide 4 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 laws.

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 our CEO, Eric Green.

Eric Green: Thank you, Quintin, and good morning, everyone. Thanks for joining us today. We will start on Slide 5. For over 100 years, the West name has come to mean so much to so many people. We have grown and expanded from manufacturing primary containment components to designing and manufacturing delivery systems. This remains the same today. As a global market leader who continues to define the evolution of our industry, our 10,000-plus team members are motivated by improving patient lives. The past few years have been a reminder that the world doesn’t stand still and the needs of the health care industry are evolving and growing in complexity with shifting treatment options from the hospital to home setting. We remain committed to the pursuit of scientific innovation and partnerships to address the changing needs of today and into the future.

Moving to Slide 6. Looking back at the year, I’m pleased to report that West delivered overall organic sales growth of approximately 8%. This growth was generated despite a rapidly shifting pandemic landscape. We started 2022 expecting COVID-19 volume growth, but instead decline in orders and demand from our customers actually resulted in a 15% decline in pandemic-related sales. Excluding COVID-19, we estimate that our base organic sales growth was low double digit, with mid-teens growth in proprietary products, and driving this base growth is demand for our high-value product offerings for both legacy as well as recently launched drugs, and we ended the year with a return to growth in Q4 in contract manufacturing. This performance is a result of the dedication and relentless focus of our team members across the globe.

We are connected by a strong responsibility and shared values that continue to help us succeed each day. I want to acknowledge these efforts and say thank you. Looking ahead, we remain well positioned with the right growth strategy around execute, innovate and grow. Our solid order book of committed orders reinforces the criticality of West’s components and devices to address our customers’ growing injectable drug demand, and we continue to deploy capital investments to support the increase in demand driven by the attractive end markets. Turning to Slide 7. In addition to our financial momentum, there were several other notable accomplishments in 2022. We shipped close to 47 billion components touching billions of patient lives. As scientific and technical leaders in the industry, our customers expect us to help solve their problems.

We continue to broaden insights with our expertise through our webinars, published articles and technical presentations. We partnered with Corning to build a next-generation leading elastomer-glass system. We launched Daikyo CZ 2.25 ml insert needle syringe to support the biologics market and secured 3 additional FDA-approved drugs using our SmartDose technology as we continue to bring additional value to our customers. Lastly, we donated $2.75 million, but more importantly, our team members continue to volunteer their time to help our local communities with the greatest needs. Our heartfelt thoughts are with all those impacted by the devastating earthquake in Turkey and Syria, where we have provided aid through UNICEF. Shifting to Slide 8.

We continue to factor environmental considerations into every aspect of our business. Over the past 5 years, we have made tremendous strides across the 6 priority areas and newly defined performance indicators. I’m pleased that we’re on target with 90% of our operational waste not being sent to landfills. Our pursuit of renewable energy alternatives has aided in a positive impact in the emission reduction. These efforts have been recognized with numerous ESG accolades in 2022. We look forward to sharing more detail in our corporate responsibility report to be published in the spring. Turning to Slide 9. We continue to address the growing market needs with today’s complex and sensitive molecules. At the recent Pharma Pack meeting, we introduced several new products for large volume delivery and complete vial containment solutions.

One available product is our West Ready Pack with Corning’s Valor ready-to-use vials. This will be the first of many products from our Corning partnership. The combination of these products eliminates the risk of delamination and reduces glass particulate in bulk filling lines. It is drug delivery innovations like this that ensures best-in-class performance with a value proposition to meet the increased regulatory expectations with a complete vial containment solution. Moving to Slide 10. We are introducing full year 2023 financial guidance. This guidance is based on demand trends as well as our current capacity levels. It’s also reinforced by our strong West and Daikyo participation rate in drug approvals, especially in biologics and biosimilars.

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We expect full year overall organic sales growth of approximately 3% to 4%, which includes a $303 million year-over-year decline in pandemic-related sales. Excluding this impact, we expect mid-teens overall base organic sales growth with proprietary products growth in the high teens and high single-digit growth in contract manufacturing. 2023 will represent a transition year for our margin profile as we see a headwind from COVID-19 HVPs. That said, our expected margins for this year are significantly above pre-pandemic 2019 levels. This underscores the strength of our financial construct with annual margin expansion of 100 basis points or more per year. In 2019, we posted operating margin of 16.1%. In 2023, we expect operating margin of 23% to 24%, which would represent an increase of approximately 800 basis points over a 4-year period.

Also, today we announced that the Board of Directors has authorized a new share repurchase plan as our prior plan was completed last year. This program is authorized for up to $1 billion of share repurchase. We note that this new program does not have a specified end date. As comparison, in 2022, our 12-month program was completed at $203 million of buybacks. And in 2021, our 12-month program was completed at $137 million of buybacks. This new $1 billion program will provide for a continuation of our share count-neutral strategy, which is assumed in our 2023 full year financial guidance. We believe this program will also provide flexibility for incremental share repurchases depending on various factors such as economic and market conditions.

Turning to Slide 11. As you can see from our guidance, we seek continued base momentum in 2023, and we’re planning for a further additional growth as our customers are preparing for expanded success of their current biologics portfolio and drug launches. As such, we continue to drive forward to complete the installation of our capital expansion plans for additional HVP capacity. The picture shows the progression of our ongoing efforts. On my recent visit to Kinston, it was impressive to see the additional space added to accommodate the installation of new manufacturing equipment to address the growth of HVPs and plungers. Together with other site expansions, this will support future demand across our global manufacturing network. Now I’d like to turn the call over to Bernard.

Bernard Birkett: Thank you, Eric, and good morning. We will first look at Q4 2022 revenues and profits, where we saw low single-digit organic sales growth and a decline in operating profit and diluted EPS. 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 review our 2023 guidance. First off, Q4. Our financial results are summarized on Slide 12 and the reconciliation of non-U.S. GAAP measures are described in Slides 20 to 23. We recorded net sales of $708.7 million in the quarter, representing organic sales growth of 2.6%. COVID-related net revenues are estimated to have been approximately $55 million in the quarter, an approximate $69 million reduction compared to the prior year.

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 13. Proprietary Products sales grew organically by 1.8% in the quarter. High-value products, which made up approximately 72% of Proprietary Product sales in the quarter were flat compared to the prior year due to the reduction in COVID-related net revenues. Looking at the performance of the market units, the generics market unit delivered double-digit growth led by ambition components and admin systems, while the pharma market unit experienced high single-digit growth led by NovaPure and Westar components. And the biologics market unit saw a mid-single-digit decline due to a reduction in sales related to COVID-19 vaccine.

Our Contract Manufacturing segment experienced net sales growth of 7% in the fourth quarter, primarily driven by sales of health care-related medical devices. Our adjusted operating profit margin of 22.4% was a 350 basis point decrease from the same period last year. Finally, adjusted diluted EPS declined 13.2% for Q4. Excluding stock-based compensation tax benefit of $0.06 in Q4, EPS declined by approximately 13.6%. Now let’s review the drivers in both our revenue and profit performance. On Slide 14, we show the contributions to sales growth in the quarter. Sales price increases contributed $28.1 million or 3.8 percentage points of growth. Offsetting price was a foreign currency headwind of approximately $41.3 million and a negative mix impact of $8.9 million, primarily due to a reduction in COVID-19-related net demand.

Looking at margin performance, Slide 15 shows our consolidated gross profit margin of 37% for Q4 2022, down from 41.1% in Q4 2021. Proprietary Products fourth quarter gross profit margin of 41.6% was 470 basis points lower than the margin achieved in the fourth quarter of 2021. The key drivers for the decline in Proprietary Products gross profit margin were unfavorable mix from a reduction in sales related to COVID-19 vaccine and continued inflationary pressures on our plant costs, including raw materials, labor and overheads. The headwinds were partially offset by sales price increases. Contract Manufacturing fourth quarter gross profit margin of 15.4% was 110 basis points below the margin achieved in the fourth quarter of 2021. The decrease in margin is largely attributed to 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 16, we have listed some key cash flow metrics. Operating cash flow was $724 million for the year, an increase of $140 million compared to the same period last year, a 24% increase. Operating cash flow in the period benefited from our working capital improvement. In 2022, we spent over $284 million on capital expenditures, a 12% increase over 2021. We continue to leverage our CapEx to increase our high-value product manufacturing capacity within our existing facilities in the U.S., Germany, Ireland and Singapore. Working capital of approximately $1.4 billion increased by $252.6 million from 2021, 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 of $894.3 million was $131.7 million higher than our December 2021 balance. The increase in cash is primarily due to our operating results in the period, offset by our share repurchase program and higher CapEx. Turning to guidance. Slide 10 provides a high-level summary. Full year 2023 net sales guidance will be in a range of $2.935 billion and $2.96 billion. There is an estimated headwind of $30 million based on current foreign exchange rates. We expect organic sales growth to be approximately 3% to 4%. We expect our full year 2023 adjusted diluted EPS guidance to be in a range of $7.25 to $7.40. Also, our CapEx guidance is $350 million for the year. There are some key elements I want to bring your attention to as you review our guidance.

Estimated FX headwind on EPS has an impact of approximately $0.11 based on current foreign currency exchange rates. We expect full year COVID-19 related net sales to be approximately $85 million compared to $388 million in 2022. And our guidance excludes future tax benefits from stock-based compensation. I’d now like to turn the call back over to Eric.

Eric Green: Great. Thank you, Bernard. To summarize on Slide 17, the solid financial performance shared today continues to reaffirm that our growth strategy is working. We have a durable base business proven by our market-led approach which is 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. And we’re continuing to progress capital spending across our operations to meet current and anticipated future growth. We realize that our products in pursuit of scientific innovations are critical to health care across the globe which is why we’re so committed to support patient health today and well into the future. Shannon, we’re ready to take questions. Thank you.

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Q&A Session

Operator: . Our first question comes from the line of Larry Solow with CJS Securities.

Lawrence Solow: Congrats on a good quarter, better than obviously we expected. Eric, maybe could you just discuss sort of the long-range outlook. HVP, I know you mentioned 72% of volume in the — revenue in the quarter. But could you speak to it more on a volume basis and particularly some of the faster growing and higher margin, NovaPure and as you kind of send up the HVP curve, if you will, I mean, the opportunities over the next several years?

Eric Green: Yes. Thanks, Larry. No, you’re right. So if you think about HVP right now, the amount of units produced from our manufacturing sites is roughly around 23% of the total volume. But as you rightly pointed out, it was about 72% of our sales in the last quarter. And the higher growth part of that high-value product spectrum of the portfolio is coming from our FluroTec all the way up to NovaPure. So NovaPure is becoming more meaningful. Obviously, it was a major element of the COVID-19 response. But with the number of biologic launches, the NovaPure is becoming a very attractive solution for our customers. So I would say it’s early. The investments that we’re making, particularly in our HVP plants of Kinston, Jersey Shore are around NovaPure plungers and other types of plungers to address future launches. So that’s where the growth is really out portion is coming from the higher end of HVP as we speak.

Lawrence Solow: Okay. And how about just — yes, go ahead, I’m sorry.

Bernard Birkett: If you look at the CapEx guidance as well that approximately 70% of that CapEx number is really to support growth initiatives and productivity improvements. And much of that is around high-value products. So that ties in with the outlook that we would see for the next number of years putting that capacity in place.

Lawrence Solow: And what about just generally in the industry, I know the trends have been biologics are obviously growing faster than overall drugs. Has that trend like accelerated over the last few years? Or what’s the outlook there on a general macro level?

Eric Green: Yes. We believe the biologics and biosimilar space is going to be the fastest-growing area for new drug launches. If you think about the last year, though, however, it was interesting to see the number of ANDAs and also small molecules approved into the market. And fortunately, we have a strong position in those areas also. But I think if you kind of fast forward, you’ll still see biologics and biosimilars be the fastest growth area in our space.

Lawrence Solow: Got it. And then just lastly, can you just give us sort of a — just a brief update on the call, not sure if you had talked a little bit about Corning at all, but just sort of where we stand there? I know I think last year, you had even called out how much you’re spending on R&D. I’m sure it’s a pretty incremental piece this year as well. But I don’t know what you could speak to on the R&D side and the cost, but maybe just sort of where we stand qualitatively, the revenue outlook and how big this could be over the next few years?