西式醫藥服務 (WST) 2020 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Q2 2020 West Pharmaceutical Services Earnings Conference Call. (Operator Instructions) Please be advised that today's conference is being recorded. (Operator Instructions)

I would now like to hand the conference over to your speaker today, Quintin Lai, Vice President of Investor Relations. Please go ahead, sir.

Thank you, Josh. Good morning, and welcome to West's second quarter 2020 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 our updated outlook for the full year 2020. There is a slide presentation that accompanies today's call, and a copy of the presentation is available on the Investors section of our website.

On Slide 2 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, and 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 West's CEO and President, Eric Green.

Thank you, Quintin, and good morning, everyone, and thank you for joining us today. I would like to begin by saying that I'm incredibly proud of how our team members across the globe have remained steadfast in our commitment to supply the much-needed components and solutions to our customers under tough circumstances. Our Q2 performance emphasizes the continued resolve of our talented team members, the strength of our company and the criticality of the role West plays during these unprecedented times.

We are in the business of helping our customers bring new medicines and treatments that improve the lives of patients, which [could] be more meaningful than at times like today. Driven by our mission, we experienced another solid quarter reinforced by the right market-led strategy to continuously deliver value for our customers and the patients we jointly serve.

Moving to Slide 4. The pandemic remains our priority. Given the ever-changing situation, there's a huge sense of urgency in vaccine development. As the market leader, our teams are working tirelessly with our customers to ensure we supply the right components and solutions to help resolve this pandemic. The process for selecting the best high-quality packaging components for use with injectable medicines, including vaccines, is a complex one, driven by years of science, which West has pioneered. We're helping our customers in the selection, testing and verification of components. We're doing this in a way that prepares our customers for the future commercial scale up and launch of any successful vaccine candidates. As we stated during our first quarter earnings call, we have seen a high adoption rate of our fluoropolymer coated stoppers made by both West and our partner, Daikyo. These are the industry standard for packaging sensitive molecules with an outstanding track record of quality and reliability.

Notably, some of our customers have selected NovaPure, as they have made this decision to use the best-in-industry component to ensure the highest degree of quality and safety. As our customers' vaccine development rapidly moves into clinical trials, the entire West team has stepped up to make certain we can supply the demand for our high-value products as well as any immediate surge in request for therapeutics. The organization is also preparing for the potential volume surges that could come if and when vaccines are approved for human use. All the work over the past few years across the enterprise to drive commercial and operational excellence, along with globalizing West's manufacturing operations, has put us in the best possible position to meet the future pandemic demand.

We are accelerating our capacity expansion to manufacture FluroTec and NovaPure components. These investments were in our 5-year plan, and we have brought them forward to address the expected increase in demand the latter part of this year and into 2021. From our perspective, it is still too early to estimate how much volume could be generated by vaccine packaging. However, whether it's hundreds of millions or billions of doses, our West team is prepared and ready when the time comes.

Turning to Slide 5 and our performance in the second quarter. Our financial position remains strong. I'm pleased to say that the growth trends we have experienced over the past several quarters have continued in the second quarter, and the outlook for the balance of the year remains positive. We had 14% organic sales growth in the second quarter, driven again by robust high-value product sales. And with HVP sales growth, we have experienced strong gross and operating profit margin expansion. This resulted in a strong adjusted EPS for the second quarter.

To be clear, the majority of the organic growth in the second quarter was from our base business with some incremental growth coming from COVID-19 sales related to therapeutics. As for guidance, we believe we are well positioned for the second half of the year. That said, because of the strength and resiliency of our core underlying business and the incremental opportunities being presented to support our customers with COVID-19 solutions, we are raising our guidance for the remainder of the year.

Now I'll turn it over to our CFO, Bernard Birkett, who will provide more detail on our second quarter financial performance and the outlook. Bernard?

Thank you, Eric, and good morning. I hope everyone continues to be healthy and safe during this time. So let's review the numbers in more detail. We'll first look at Q2 2020 revenues and profits, where we saw strong sales and EPS growth, led by strong revenue performance primarily in our biologics and generics market units and Contract Manufacturing. I will take you through the margin growth we saw in the quarter as well as some balance sheet takeaways. And finally, we'll review guidance for 2020.

First up, Q2. Our financial results are summarized on Slide 6, and the reconciliation of non-U.S. GAAP measures are described in Slides 13 to 17. We recorded net sales of $527.2 million, representing organic sales growth of 14.3%. COVID-related net revenues are estimated to have been approximately $19 million in the quarter. These net revenues include our assessment of components associated with treatment and diagnosis of COVID-19 patients, offset by lower sales to customers affected by lower volumes due to the pandemic and stay-at-home restrictions, such as dental, veterinary and elective procedures.

We continue to see improvement in gross profit. We recorded $195.1 million in gross profit, $37.2 million or 23.6% above Q2 of last year. And our gross profit margin of 37% was a 340 basis point expansion from the same period last year. We saw improvement in adjusted operating profit, with $106 million recorded this quarter compared to $81.9 million in the same period last year for a 29.4% increase. Our adjusted operating profit margin of 20.1% was a 270 basis point increase from the same period last year. Finally, adjusted diluted EPS grew 40% for Q2. Excluding stock tax benefit of $0.09 in Q2, EPS grew by approximately 38%.

Moving to Slide 7. Our proprietary product sales grew organically by 13.3% in the quarter. High-value products, which made up more than 65% of proprietary product sales in the quarter, grew double digits and had solid momentum across all market units throughout Q2. Looking at the performance of the market units, the biologics market unit delivered strong double-digit growth. We continue to work with many biotech and biopharma customers who are using West and Daikyo high-value product offerings.

The generics market unit experienced double-digit growth led by FluroTec and film-coated products sales. Our Pharma market unit saw low single-digit growth, with sales led by high-value products and services, including Westar and FluroTec components. And Contract Manufacturing had double-digit organic sales growth for the second quarter, led, once again, by sales of diagnostic and health care-related injection devices.

So what's driving the growth in both revenue and profit? On Slide 8, we show the contributions to sales growth in the quarter. Volume and mix contributed $59.4 million or 12.6 percentage points of growth, including approximately $19 million of volume driven by COVID-19-related net demand. Sales price increases contributed $7.8 million or 1.7 percentage points of growth, and changes in foreign currency exchange rates reduced sales by $9.6 million or a reduction of 2 percentage points.

Looking at margin performance. Slide 9 shows our consolidated gross profit margin of 37% for Q2 2020, up from 33.6% in Q2 2019. Proprietary products second quarter gross profit margin of 42.8% was 330 basis points above the margin achieved in the second quarter of 2019. The key drivers for the continued improvement in proprietary products gross profit margin were favorable mix of products sold, driven by high-value products; production efficiencies; and sales price increases, partially offset by increased overhead costs.

Contract Manufacturing second quarter gross profit margin of 19% was 470 basis points above the margin achieved in the second quarter of 2019. Improvement is a result of improved efficiencies and plant utilization. There was approximately 180 to 200 basis points positive impact on margin, primarily due to a onetime engineering project work. Our adjusted operating profit margin of 20.1% was a 270 basis point increase from the same period last year, largely attributable to our gross profit expansion. One point to note, we took a onetime charge of $6.3 million for asset impairment. This is included in other operating expenses.

Now let's look at our balance sheet and review how we've done in terms of generating more cash for the business. On Slide 10, we have listed some key cash flow metrics. Operating cash flow was $205.2 million for the year-to-date 2020, an increase of $52.5 million compared to the same period last year, a 34% increase. Our year-to-date capital spending was $69.2 million, $12.1 million higher than the same period last year and in line with guidance. Working capital of $735.4 million at June 30, 2020 was $18.3 million higher than at December 31, 2019, primarily due to an increase in inventory, mainly as a result of increasing our safety stock levels and accounts receivable due to increased sales activity.

Both DSO and DPO improved in the quarter. Our cash balance at June 30 of $445.9 million was $6.8 million more than our December 2019 balance, primarily due to our positive operating results. Our capital and financial resources, including overall liquidity, remain strong.

Turning to guidance, slide 11 provides a high-level summary. Full year 2020 net sales guidance will be in a range of between $2.035 billion and $2.055 billion. This includes estimated net COVID incremental revenues of $60 million. There is an estimated headwind of $26 million based on current foreign exchange rates. We expect organic sales growth to be approximately 12.5%. This compares to prior guidance of $1.95 billion to $1.97 billion and growth of 8%. We do expect growth in Contract Manufacturing to be less in H2 versus H1 as a result of tougher comps. We expect our full year 2020 reported diluted EPS guidance to be in a range of $4.15 to $4.25 compared to prior guidance of $3.52 to $3.62.

As Eric discussed, we are expanding our HVP manufacturing capacity at our existing sites to meet anticipated 2021 COVID-19 vaccine demand. CapEx guidance has raised to $170 million to $180 million. This compares to previous guidance of $130 million to $140 million.

There are some key elements I want to bring your attention to as you review our guidance. Estimated FX headwinds on EPS has an impact of approximately $0.07 based on current foreign currency exchange rates. The revised guidance also includes $0.16 EPS impact from our H1 tax benefits from stock-based compensation.

So to summarize the key takeaways for the second quarter, strong top line growth in both Proprietary and Contract Manufacturing, gross profit margin improvement, growth in operating profit margin, growth in adjusted diluted EPS and growth in operating and free cash flow. Our long-term construct remains at approximately 6% to 8% organic sales growth and continued EPS expansion.

I'd now like to turn the call back over to Eric.

Great. Thank you, Bernard. We have a rich history of leading in times of great challenge. Our customers expect this of us, and this is what we're committed and prepared to do. I want to emphasize that across West, we are leveraging our global manufacturing capabilities, size and scale to innovate, lead and operate with a sense of urgency to make a positive impact in health care and society. Our performance continue to reaffirm that our market-led strategy is delivering unique value propositions to our customers. Our global operations team is efficiently manufacturing and delivering products with market-leading service and quality. And we're continuing to invest in our business with digital technology and automation across our operations to field an even brighter future. We remain committed to deliver value to all our stakeholders on a sustainable basis as well as to maintain and build upon the values that make up our One West team.

On behalf of the team members at West, we continue to wish you good health in the days ahead. Josh, we're ready to take questions. Thank you.

(Operator Instructions) Our first question comes from Juan Avendano with Bank of America.

Congratulations on the quarter and the role that you're planning in the COVID response. My first (multiple speakers) yes. My first question is, what is the mix between FluroTec and NovaPure components that you're seeing being evaluated by the COVID vaccine players? And any thoughts on the most likely packaging format, such as single dose or multi-dose and how many doses in the multi-dose?

Yes. Juan, let me take these 2 questions. One is, in regards to FluroTec and NovaPure components, primarily most of the interest with -- and again, we have a pretty healthy participation rate with the number of companies working on a vaccine solution. In the vaccine area, we're seeing more interest around FluroTec as the primary technology and -- versus NovaPure. Now there are certain situations where NovaPure is a better solution, and customers have elected to go in that direction, but the majority, I would say, is in FluroTec. In some of the therapeutics that we're working on, where they're already marketed or being labeled expanded, that's using the combination, mostly NovaPure and some FluroTec.

In regards to the second part, that's a tough question where we stand today. As you think about how our customers are looking at vial configuration, whether it's one dose or multiple doses per vial. And it's a little bit uncertain at this point in time. But the way that we've mapped out all these opportunities with our customers, each one is a little different from a number of doses, the volumes that we're looking at would accommodate either one dose or multiple doses per vial. But at this point in time, I think it's pretty difficult to pinpoint exactly number of doses per vial that our customers will be going with.

Appreciate the responses and the color there. And my second question is, we've seen a number of public announcements from Corning silicon oxide or SiO2 and ApiJect on the glass vial supply side for COVID-19. I would have expected to have seen something on Crystal Zenith from West. And so my short question is, what can you tell us about Crystal Zenith, how it compares competitively versus some of the other solutions out there that have gotten government grants for the COVID response? And what sort of COVID opportunities are you seeing for Crystal Zenith?

Yes. It's -- we look at it a little differently. I think when you think about the preferred solution in the market right now is still glass. And so I know that the companies that are manufacturing glass are working on making sure they have the appropriate volumes, but I can't speak to them specifically. When you think about Crystal Zenith, it's already a proven technology in the marketplace with a number of critical drugs, specifically around the biologics. And the demand that we have for Crystal Zenith is increasing. In fact, we are in process of increasing capacity in our Scottsdale, Arizona facility to address the increase around our 1mL Insert Needle technology.

We do see certain customers that require the Crystal Zenith technology in the areas of vaccine exploring that option. But I would say, at this point, we have not gone out and sought government grants. Frankly, I think our company, as the market leader, we're leading from the front, and we've worked with a number of customers around the CZ technology. But I would say right now, what it looks like is that the preferred solution on the immediate phase would be around glass.

Our next question comes from John Kreger with William Blair.

Can you talk a bit more about your CapEx expansion plans? Are you -- can we assume you're running sort of at full tilt at this point, or do you have the ability to flex your output with your current configuration? And when can we expect the new capacity to come online that you talked about with the higher CapEx budget?

Yes, John, what we have done is we decided to bring forward capital in regards to specifically equipment that will be placed strategically in 3 of our center of excellence sites of high-value products. We had these -- this equipment earmarked for latter years based on trajectory of our current business and our current portfolio. But due to our discussions with customers, we are preparing to make sure that we'll be able to address this surge that we'll see, specifically around FluroTec stoppers in the marketplace.

Now, in regards to the timing, we're looking at towards the end of this year of having the capacity installed and validated, and we will be able to start the expansion of volume at that point in time. Bernard, do you want to talk a little bit more on the...

Yes, on the timing, John, some of the capacity will be in -- at the end of this year, and it's particularly related to FluroTec products, and then we will be layering in incremental capacity early on in 2021. And so all of the commitments that we have needed to put in place are actually in place with our equipment suppliers at the moment. So we'll have a phased introduction of that equipment so it won't have any -- it won't disrupt our business in any way. All of the equipment that we're ordering is replicating equipment that we already have in place at West, so we're really set up well to make sure that we can onboard that equipment quickly and meet customer demand.

Excellent. And just to follow-up to that, what sort of capacity boost will that give you for FluroTec, if you're willing to say?

Yes. We haven't revealed exactly the amount, but it's significant, in the areas around FluroTec, specifically.

Yes, so based on all of the discussions we've had with customers and analyzing where -- a number of different models, we believe that we will have sufficient equipment in place to meet any customer demand when it comes.

Excellent. I guess one last one. Anything you can add on the sustainability of the pickup in growth in Contract Manufacturing?

Yes. What's happening with the Contract Manufacturing really is around the diagnostics area and also injectables, auto injectors. And what we're finding is this -- a lot of this is installed capacity that we've been ramping up for the last couple of years. We do see that the growth rate of high single digits to low double digits is more in line with what we expect of Contract Manufacturing, and it has been running a little bit stronger over the last several quarters.

But on the other side, we continue to have discussions about future installed capacity of similar products. So we see the second half of this year a little bit softer than the first half from a Contract Manufacturing perspective.

But that's purely a comp issue on the growth rates. From a dollar perspective, we don't see any softening in Contract Manufacturing. You can see the revenue itself growing, but it will grow at slower rates, purely because of the comps that we're facing in the back half of the year. And you can see the positive impact that's having, John, on margins, where we were able to report 19%.

Now, there were some onetime gains in there regarding certain engineering work that we were doing, which we would not expect to repeat in the second half of the year, but we forecast to see strong quarter-over-quarter growth when we compare to last year on the margin front. And this is something that we've been talking about for a while as we continue to improve the efficiencies and the utilizations within the Contract Manufacturing network and taking a lot of the learnings that we've had in Proprietary over the last number of years and really starting to implement those within Contract Manufacturing. So I would continue to see -- expect to see margin expansion, but not to the levels of 19%.

Our next question comes from Dave Windley with Jefferies.

Congrats on the nice acceleration. I wanted to ask a couple of questions around your COVID vaccine comments. We are hearing from some other vendors that are involved in the development, whether it be in clinical trial space or maybe contract manufacturing space, about the government's involvement in the overall funding -- or various governments, I guess I should say, in the overall funding of these development activities and discounting as a result. And I guess I want -- you're clearly calling out FluroTec and NovaPure and you have for a little bit. Are you getting or expecting to get full price on those volumes when they ultimately scale up and go commercial, hopefully?

Yes, Dave, our agreements with our customers are based on historic and also current price points, so we are looking to obtain what we traditionally have received for those products. I realize that there's some funding going into certain manufacturing or R&D side, but we're not seeing the money really going into the percentage of COGS or the money going into the COGS of the supply base, so it's low. If you think about our product on a configuration, could be anywhere between $0.15 to $0.35. If it's one dose or 5 dose, you can see how, from a per dose perspective, it's not a significant percentage of the COGS. So I think we're well positioned, and the expectation is to continue with our policies around how we price according to the value we create to support our customers.

So on the -- you anticipated where I might go next, Quintin may have tipped you off. The -- I guess the curiosity that I have is that the -- that historical argument has been one that you've made, I've certainly made, that the cost of these components as a percentage of, in most cases, a very high-priced, maybe even 4 figure per dose type price on a biologic is a very, very small percentage. When we're talking about a price per dose at what some of these companies are promising, at like $10 or if it's a 4 or 5 dose per vial, it's -- maybe it's $40 or $50 of value, is a very different equation than a $1,000 dose biologic. How is it that the interest level or the sensitivity to that price is as low as it is -- or appears to be as low as it is? And I guess to spin the question the other way, if customers are able to get over that so easily in this environment, is that a signal that the adoption rate outside of COVID for high-value products should significantly accelerate because the price sensitivity is really as low as it is?

I can take the first part of the question, and maybe Eric might want to cover the second part of the question, Dave. So -- just so we're clear, we have -- we're not getting support from any government. West is investing an extra $40 million essentially this year in CapEx and even some into 2020. We've -- obviously, we're funding that ourselves. And when you look at -- you're comparing the cost of our product to the selling -- the end selling price. What we're saying is the cost of our product is a percentage of their COGS. So their COGS doesn't change no matter what they sell the product at, the cost of producing is still the same. And we're still a relatively low part of that. And then if you work out the price per dose, potentially, there could be 5, 10, 20 doses in a vial. Well, we sell one stopper per vial, so you got to divide back the cost of the stopper by the number of doses, so it becomes a really small part of the COGS.

Regarding pricing, we haven't gone and tried to jack-up prices in this whole process. We're maintaining the pricing essentially that we've had in place on many of these products. Now, pricing changes a lot of times regarding configuration, but I think that's the way to look at it rather than saying as a percentage of their price, if that's helpful for you, and then the number of doses per vial.

And Dave, when you think about our customers have been and will -- have been using our -- if they're using FluroTec or they're using NovaPure, are very comfortable with it because they have used our components on other molecules they have in the marketplace for other purposes, especially around biologics. And so there's a comfort of when they think about how they can go to the market fast. When you think about regulatory, you think about safety, you think about quality and scale, and we have the scale. We can manufacture the volumes that we're speaking of in a very, very short period of time. So I think, Dave, that's where that gives the customers confidence and comfort to continue to go after that part of our portfolio versus using this basic standard product. And -- so I'll stop there, but that's the reason why we're seeing the demand in that area.

Okay. And maybe a last question. In the news, at least, I'm sure by numbers and perhaps the ones that don't get as much interest or press, the smaller companies are numerous. Some of the highest profile of these players chasing the vaccine and the ones in work seed, for example, I would think would be classified in your pharma segment. Can you speak to differences in growth rate that you're seeing? Is that something perhaps as simple as timing as to where those inquiries and adoption rates and sampling demand might come from in regard to, again, like just to name a couple, the AstraZenecas and J&Js of the world that are in this vaccine chase?

Yes. No, Dave, when you think about, whether it's small or large, because of the nature of the molecule, we classify that as biologic.

Okay, okay.

Yes. So when we talk about vaccines, we're all encompassing. I wouldn't try to split out the vaccine opportunities between the 3 units from our performance perspective.

Our next question comes from Larry Solow with CJS Securities.

Just a couple of follow-ups. Eric, you mentioned the $0.15 to $0.35 per vial, would that be just for FluroTec? Or what is that sort of range discussing? And you mentioned some companies -- some customers have chosen NovaPure, which I get encompasses sort of all the HVPs. Is there anybody just choosing FluroTec and maybe would Westar also potentially get into that equation?

Yes. Larry, it does vary on what the final configuration and all the additional services we provide. That number that was referenced is more around the FluroTec portfolio versus NovaPure. NovaPure is higher.

Right. Okay. And the $19 million you guys referred to in the quarter, $19 million in the quarter and the $60 million for COVID-related revenue, is that the full year number?

Yes. That's the full year.

That includes the (multiple speakers)?

Yes. Yes, that's the full year number, about $60 million that we see right now.

Got it. And I imagine some -- you'd mentioned a little bit on the therapeutic side (inaudible) I guess. And then the vaccines, I guess, obviously, it's just verification of components and testing and whatnot and then inevitably, if something is commercialized and scaled, then you would -- obviously, number would grow a lot more. Is that how we look at that?

Yes. Larry, the way I look at it -- yes, I think you're right. It's the way we break it out. And the way we're looking at -- we don't give out the numbers, but we're very -- we're segmented, so we understand what's around hospital enablement, so this is like the IV and blood tubes. You think about supporting therapies, particularly in the ICU. And then therapeutic treatments, which we have a very high participation rate because of our biologics position. Those are really the key areas when you think about more near term. As we think about vaccines, as we work with our customers, obviously, there is some element of providing product for trials, but that is obviously low volume. And therefore, we don't -- we can't -- it's very difficult to predict when and how much and by whom. So we're holding off at this point. But as we've said in our capital investment is that we are going ahead to ensure that we have the capacity in hand -- on hand by the end of this year, so we can handle the surge if it is as early as early 2021 or late 2020.

Got it. And then the margins in the quarter sort of really demonstrate the power of the operating model with 37% and 20% operating. Was there anything unusual? I know you called out a couple of hundred bps on the Contract Manufacturing side. Was there anything else unusual in the quarter that could have benefited those margins?

Other than the piece on Contract Manufacturing that I called out, Larry, all of the COVID-related costs have been recorded in COGS. They're all included in that margin number. So it's pretty clean other than the CM piece. And I think the Contract Manufacturing piece -- yes, that's about it. And then within operating margin, we called out the impairment of certain assets and that's a one-time.

Right. But you took that out on the adjusted number, right? Or is that in the adjusted number too, the write-off?

Sorry, I can't hear you.

Is the write-off in your adjusted number or you adjusted out?

In the adjusted number, it's in there.

Oh, it is in there. Okay.

We didn't back it out.

Okay. And then you mentioned some -- the increased overhead, which impacted your margins a little bit. Is that in reference to FluroTec and NovaPure or that capacity or that hasn't come online yet? It's something else I guess, right?

Yes. Well, there is costs around PPE. There's incremental costs supporting a lot of the workforce at our plants. We've gone to split shifts, so -- and we're obviously paying shift premiums to keep the plants up and running. So -- and then also, there was some incremental freight costs.

And I'm not showing any further questions at this time. I would now like to turn the call back over to Quintin Lai for any further remarks.

Thank you, Josh, and thank you, everyone, 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 Investors section. Additionally, you may access a replay through Thursday, July 30, by using the dial-in numbers and conference ID provided at the end of today's earnings release. That concludes this call. Have a nice day.

Thank you, ladies and gentlemen. This concludes today's conference call. Thank you for participating. You may now disconnect.