Good day, and thank you for standing by. Welcome to West Pharmaceutical Services First Quarter 2024 Earnings Conference Call. [Operator Instructions] Please note that today's conference may be recorded. I will now hand the conference over to your speaker host Quintin 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 Investors 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 is 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 law. These statements are based on our beliefs and assumptions, current expectations, estimates and forecasts. The company's future results are influenced by many factors beyond the control of the company. Actual results could differ materially from past results as well as those expressed or implied in any forward-looking statement made here. Please refer to today's press release as well as any other disclosures made by the company regarding the risks to which it is subject, including our 10-K, 10-Q and 8-K reports. During today's call, management will make reference to non-GAAP financial measures, including organic sales growth, adjusted operating profit, adjusted operating profit margin and adjusted diluted EPS. Reconciliations and limitations of the non-GAAP financial measures to the most comparable financial results prepared in conformity to GAAP are provided in this morning's earnings release. I now turn the call over to our CEO, Eric Green.

Thank you, Quintin, and good morning, everyone. Thanks for joining us today. We will start on Slide 5, where I'd like to cover a few topics. First, 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, NovaPure, and our HVP devices such as SmartDose. 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 6. 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 Products segment, we have expansion projects in several of our HVP components manufacturing sites, such as Jersey Shore, Kinston, Waterford and Eschweiler. These projects will provide a combination of increased manufacturing capacity, especially HVP processing, washing, sterilization…

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, a decline in operating profit and diluted EPS compared to the first quarter 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-U.S. 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 Products sales in the quarter, declined by low single digits primarily due to decreased sales from our FluroTec products and Westar components. Looking at the performance of the market units, the biologics market unit delivered low single-digit growth, led primarily by sales of NovaPure. The pharma market unit saw a high single-digit decline, primarily due to a reduction in sales of Envision and standard components, while the generics market unit declined double digits, primarily due to decreased sales from our Westar and FluroTec 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% for Q1. Excluding stock-based compensation tax benefit, EPS decreased by approximately 23%. Now let's review the drivers in both…

Thank you, Bernard. To summarize with 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. Olivia, we're ready to take questions. Thank you.

[Operator Instructions] Our first question coming from the line of Matthew Larew with William Blair.

I wanted to ask about -- you referenced the pickup in the back half of the year, but more about the second quarter. 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 an 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?

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 build and 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 4 quarters. Bernard, do you want to add any more?

Yes. Just as Eric said, Matt, sequentially, it will be up. There is an element of timing between Q1 and Q2. So some of those orders that we shipped out in Q1, 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 a 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's 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 multisource arrangements moving forward and just kind of ask that in light of all the high-value capacity you're adding.

Yes, 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 stockout with any particular customer. So we were successful through the pandemic period of time. And we have been working on reducing the backlog and increasing their safety stock levels really in back end of 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 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 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.

And our next question coming from the line of Jacob Johnson with Stephens.

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?

Yes. It was -- 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 -- so it was a solid performance for us in the quarter.

Got it, Bernard. And then maybe a longer-term question. A couple of years ago, you've 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, 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 the -- 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 if you think about the component specifications all the way to 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 1. So while we're very well positioned in both areas, it is about timing and change can take time and adoption could take time. So we are -- we would say that the long-term outlook construct is a range. But as an organization, we don't have a ceiling. So I'll leave it like that.

And our next question coming from the line of Paul Knight with KeyBanc.

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. That's -- yes, I would characterize that 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 2025 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? Is that a fair assumption? And is standard -- what's in standard packaging to make that the weakest, if it is?

Well, if I -- let me rephrase that. I think the HVP components for us, most of the destocking 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 strong outlook towards the end of the year and very strong obviously beyond that.

Yes. I think, Paul, on that, it's important to note that we don't anticipate any major mix shift. There's still the growth opportunities around HVP and in the biologics space. And even in Q1, that continued to grow. And you could see the growth driven there by the growth in NovaPure. So from a mix perspective, I think when you look at it in the whole, areas are growing. And our growth potential, as we look out past '24, around standard components and packaging and HVP, the trajectory is the same; that they are the growth drivers.

And our next question coming from the line of Michael Ryskin with Bank of America.

I just have a couple of quick follow-ups. One, I mean you talked about 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 on operating margin as well. Is it fair to say that given your comments on timing of revenues in 1Q, 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 a follow-up.

We expect margin improvement sequentially as we move through the year, and that hasn't changed since we spoke about it in February. We would see growth in 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 a little bit weaker than we had expected. Is that just a component of mix and some of the destocking you had talked about? Or should we expect price to be a bigger contributor as you go through the year? Or is that being at half level about right?

Yes. 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 mix shift. And so we started the year off in line with what we expect 3% to 4%.

And our next question coming from the line of Justin Bowers with Deutsche Bank.

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 seeing -- 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 we -- and obviously, we're -- as you know, we're make to order. So we get -- we have a purview if you 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.

Contract Manufacturing side, last quarter, you talked about some operational improvements, I think, maybe in Arizona. But 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?

It's -- this will 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 have been -- are being resolved as we speak.

Yes. And I think the productivity improvements that we're actually working on right now don't impact our current levels of production. And we would -- again, we would see a sequential improvement in the throughput around that business. So we're not looking at a step back there.

No.

Appreciate the questions and sorry the background noise. I've got some guys on my roof.

No problem.

Totally appreciate it.

No problem.

And our next question coming from the line of David Windley with Jefferies.

I was going to say Justin, let us know if you need us to come rescue you. 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?

Yes, David. So it was really 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, the volumes around that business to increase again sequentially. And that's when we talked about the destocking earlier on in the year where we're seeing it was across all different parts of our business. So we would expect that HVP growth to accelerate as we move through the year and then the margin -- and that to be reflected in our margins. And also, we'll get the pickup of incremental or increased throughput as we move through the year. I think 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 very multifactorial with so many different elements of the supply chain investing aggressively to bring up capacity, you all being an example of at least 2 different areas where you're investing. To what degree do you have dialogue with those clients or visibility to understand? You invest and you add NovaPure capacity and you add injection device capacity but fill-finish capacity is a challenge, for example, 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?

Yes, 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 -- are well established, where 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 of -- 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 is 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 we -- 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 1 or 2 years. So that's pretty typical of the model that we have today.

That's very helpful. If I could just sneak a last one in. On the destock, 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; 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. 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 4 quarters.

And our next question coming from the line of Larry Solow with CJS Securities.

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

Larry, thanks for the question. Yes, 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 #1 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 for -- to be able to support and provide product with the regulations of Annex 1. 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 -- 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 it's -- 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 like to transfer, but we're well positioned to have those discussions and then act upon them.

Great. I appreciate that color. And just a question on R&D. 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? And where is the lion's share of that increase going into? Is that -- I know a lot of investment into Corning, but is it going into a lot of different areas?

Yes, Larry, as a percentage of revenue, we expect R&D to be pretty constant as we go through the year. And where is that money going? A lot of that increase is around integrated systems and how we're building that out. And again, it is our 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 -- that also could probably move around a little bit, but is that probably a good run rate you think for the full year?

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

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

Thanks, Olivia. Thank you for joining us on today's conference call. An online archive of the broadcast will be available on our website at westpharma.com in the Investors section. Additionally, you may access the 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 does conclude our conference for today. Thank you for your participation. You may now disconnect.