Good evening, everybody. I'm Luke Sergott covering Life Sciences Tools and Diagnostics here at Barclays. It's my pleasure to have with me West, and we have CFO and COO Bernard Birkett, and Quintin Lai, who heads up everything else outside the CEO role. So I guess we could just get right to.
That's right, true.
Yeah, that's true. Let's talk about the Annex 1 regulatory shifts. Can you give us a high level of what's going on there and how you guys see that impacting your business over the next 3 months to the rest of the year?
Well, first of all, Luke, thank you, and thank you to Barclays for inviting us here. We really appreciate the opportunity. Annex 1 is just one of several things that have been talked about in the industry, and in the past we've talked about how global regulators continue to look for ways to improve the quality and delivery of drugs, especially injectable drugs, for the patients in their region. In this case, Europe has been taking a look at parenteral drugs and looking at the quality, and it's going to affect a lot of the manufacturing, including elastomers and seals, as well as other areas that are in the primary packaging and delivery, and looking to reduce the particulate load that patients are exposed to. It's gone through several comment periods.
They started to formalize some of the regulations, and some of the implications and requirements are going to come out over the next few years, starting at different times, this year, next year, etc. As we look at it, we think that given the exposure that we have and the sales that we have to customers in that region, there are some legacy products that we sell that could benefit from moving to a higher value product that we offer and to the tune of several billion components over the next few years.
And so, is it, so you're talking about they're taking a deeper look into the particulate matter? Does that require anything from your any investment on your side on the manufacturing? Do you get any step-up QA/QC?
Well, we already cover it by the products that we offer through our high-value product range, so there's various levels of higher levels of quality that will take care of the Annex 1 issues or the problem that's trying to be solved with it. So it's really having customers convert their standard product to HVP product, and then even within the HVP product portfolio itself, customers may move further up that curve over time. We expect this to—it's going to take time for that to happen. We believe it's a multi-year process. We don't see one big, large event happening, so it'll bleed in over time. But it helps support our mix-shift strategy and links back into our long-term construct of 7%-9% growth, particularly focusing on that mix-shift element, and that in itself drives higher levels of profitability.
So it's not really a volume play for us. It's converting volume that exists already and then any growth that comes from that.
Have you already started to see, I mean, you talked about in equity, 1 point of revenue headwind from a conversion towards this, give us a sense of early demand or early conversations that you're having, timing, and how that kind of is going to shake out?
Yeah. So the one that we called out when we gave guidance earlier this quarter was really that customer was ready to convert. They had the work actually done, but given some things that were happening internally with them, they decided to postpone it. So it's not if but when. It's the question on that. But to get there, we've been working with that customer probably for over a year to get them prepared and making sure that we have the infrastructure in place to support that. For future customers who want to convert, we have been layering in capacity around our HVP processing, particularly around Envision and PharmaWash, to be able to support that incremental demand. So there's a number of conversations ongoing.
As we said, we haven't baked a whole lot in this year, but when we move, I think, past 2024, we'll see more of those conversions take place.
All right. Do you think that the FDA follows suit?
If you look at, we're not going to comment on specific regulatory agencies. It's easier for us to talk about things that have been implemented or codified. But one thing, global regulators, they all look at each other. They get information from each other. There's a lot of information sharing. And so I think from our perspective, our expectation being in this industry is we expect general regulations to continue to raise the bar over time.
Yeah, that makes sense. You talked about your February order coverage being at higher than the pre-pandemic levels. Give us a sense of how this trended, let's say, from November, December through January, just to kind of get an idea of the momentum that you guys are seeing.
Well, it's not that our February coverage was greater than pre-pandemic. But what we called out, again, when we gave guidance to say that we were going to see most of the destocking event take place here in Q1, and then we would expect to see progress from a revenue perspective as we move through the rest of the year with incremental step-ups each quarter. What we looked at to give us a level of confidence around that is looking at the order patterns, particularly in the back half of the year, where we're seeing, as a percentage of forecast, the number of orders that we have in place today versus pre-pandemic levels. And so that percentage of forecast that's covered by actual orders in our system is greater than what we would have seen pre-pandemic. So we know that cover is there, and we're seeing that strength.
What we also commented on was that over the last month or two, we've seen the cadence of orders coming in a little bit ahead of where we'd originally predicted. Now, when that product gets delivered, it could be Q1 into Q2 or Q3. But we are seeing that, which gives us confidence that, at this point, we believe we've ring-fenced that destocking event based on these data points that we're seeing. And that's given us that level of confidence around our guidance.
Is this an order starting to recover quicker? Is this a particular customer, or is this a group of?
No, it's a group of, or is this wholesale? It's across the board. Again, it's really a data point. It's not as if it's a huge number, but we are a little bit ahead of where we expect it to be. So we felt it was important to share that information as soon as we started to see that materialize just to support the narrative that we had given around the guidance.
Okay. And then I guess let's turn to the BIOSECURE Act here. I mean, it's kind of jumping around all over the regulatory areas. But so how do you think about with WuXi and the manufacturing and the impact on them? How do you guys see that shaking up near-term for you? Is that a disruption for you, or? I mean, obviously, the work is probably going to get taken up by somebody else. Is it just more of a push-out? How do you guys think about that?
I'm not quite sure how that fits in.
All right. We'll go to the next one. All right. Let's go through your guide for the year. 2%-3% for the full year. You just talked about your LRP being 7%-9%. Kind of give us the underlying assumptions for the segments.
Yeah. So around the 7-9 is really made up of three components. You've got volume, usually 2%-3%, price, again, 2%-3%, and then the rest is made up with mix shift. And the three components have been fairly constant as we've been looking at the LRP. The volume, that's typically what we see on an annual basis. But the volume does vary between our market units. So biologics will be higher than that. And then generics and pharma, around that range, are a little bit lower. As we see it progressing through the year, as I mentioned, in Q1, we're going to see the major impact of the destocking. Then as we move into Q2, we do see some improvement in getting back into construct as we exit the year.
All right. And then the HVP device manufacturing headwind to start, kind of walk through what's going on there.
Yeah. So that's really around an event. We're onboarding an automated line to support our delivery device business. And that's taken a little bit longer than we would have anticipated given the complexity involved. So we have a lot of demand for the product. Our issue is actually meeting that demand right now. So we're a capacity constraint. So when that comes in towards the back end of the year, it'll actually free up that capacity, and we'll be able to start meeting customers' expectations. I'd say that's more of right at the back end of the year, early into 2025.
As you think about those new volumes coming through that new line or the new process, have you made any operating efficiencies versus your legacy business, or is it just really a one-to-one?
Well, there will be some operating efficiencies given the level of investment we've made. But it's really, can we get the throughput and meet that demand? And then you get a more, I think, sustainable and robust manufacturing process when that's in place.
Yeah. And then also, you guys talked about you had a customer upgrading to the higher-tier, high-value products, and that kind of being a little bit of a speed bump, if you will. What's going on with how long does it typically take for a customer to switch? Do they have FDA submission? What goes on?
It depends. So if you're looking at, let's say, a customer that is using a formulation of ours that has been around for quite a long time and has been grandfathered in because it was approved years ago, if they were to move to a new formulation, you're going to have to do full stability testing. And so it's going to be time, effort, cost in order to show that it can be that you can move to that. If it is something that is already using what we would call a modern formulation, but they right now just buy it unwashed, then it's more of a process. So because of our processes of washing, sterilizing, Envision, you're not really doing anything to the native rubber. You're just making it cleaner. Those are much easier kind of addendums. And so it depends on what the customer is looking to upgrade.
We think that there's opportunity for both, for both legacy formulations as well as those that may be using the modern formulations but at an unwashed level to move up.
All right. And then so on your guide, can you give us the underlying assumptions for proprietary products and the contract manufacturing?
Yeah. So contract manufacturing, we would expect to be flat for the year. Then on our proprietary business, you're probably looking about just that, let's say, just north of 3% growth. That gives you the range of 2%-3% on the guide.
All right. And then on the proprietary, can you dig in on what you guys are your underlying assumptions for the HVP components, devices, then the bulk?
So the way to look at components, which is still the majority of our HVP, will be growing within construct. And we think devices, which are a much smaller portion, I mean, right now, only 10% of our order size, we think will grow faster over the near term.
All right. On that devices side, as you guys think about that kind of scaling up and growing itself, you understand, small portion, but give us a 2-3-year outlook for that, how that growth is going to look like.
So devices is a little different. So when you compare it to our component side, we sell to thousands of customers. They sell to many drugs. It's more of a portfolio. When you start looking at devices, in the case of things like our delivery device, there's only a handful of customers, and it really is a function of the success that those customers have with their drugs. So it can be more drug-dependent. And so as our customers continue to gain traction, increase indications, perhaps move into new geographies, we have an opportunity to grow as they grow volume.
All right. And then with the high-level biologics approvals that we've had last year, I think we crested over what we did in 2022 or 2021 and 2022. So how long typically does it take you guys see that to scale up through your portfolio? Obviously, as soon as they're manufactured, you're on it. But as you can transition them through that, up the scale of the HVPs.
Yeah. So the recent approvals, especially biologic large molecule, they usually start off at modest volume. And now that incremental volume that does come in usually is associated with our highest value product, so FluroTec, for example, NovaPure. So that delta V is multiplied by something that has got a pretty good price, which then generates that sales contribution. And then kind of like what I said with the devices, as those customers get success, they see indications expansions. As they move into new geographies, then the volume does increase. So that has been the pattern that we've seen. And so newly approved biologics, they start off modest, but then as they continue to gain traction and adoption, reimbursement, other drivers in the market, then it becomes a bigger and bigger portion for us.
So if you look at just our sales, I mean, 2016, of the three market units we had, biologics was the smallest in terms of sales. Here we are now, as of 2023, it is not the largest. That just shows you the impact of the growth of especially some of those drugs that have been introduced over the last 8, 9 years.
Yeah. So typically, what we see and again, it's within that 7%-9% construct that biologics grows double digits on an annual basis. And then the vast majority of biologics is HVP. And then in generics, you get mid- to high single-digit growth. And there is HVP participation there. But again, it's at a lower level, and there's still a market that we can capture. And then the lowest level of participation in HVP is in pharma. And again, that's kind of low single-digit, mid-single-digit growth for us. So the focus for us is really a lot of it is around biologics. And that leads back into that HVP conversion or growth and then leads into the operating margin expansion.
And then within that 7-9 construct and biologics at double digits, it's clear that the demand from the overall industry and the number of drugs coming out continues to increase. But talk about the investment that you're making or you guys need to make to maintain that growth. You talked about, I think, 70% of your CapEx going towards growth.
Yeah. So typically, pre-COVID, we were investing around 6%-7% of revenues in CapEx. And at that time, we were probably seeing about 50%-60% of the CapEx targeted towards growth. So what we have seen is we've had to step up our CapEx deployment over the last number of years. I think last year, we ended at about $360 million. This year, we're targeting $350 million. So just over 10% of revenues, 10%-12% of revenues. But 70% of that capital is deployed against growth initiatives, and much of that is targeted towards high-value products. And again, so that was responding to COVID, putting the infrastructure in place, but really pulling CapEx forward in a response to COVID, but knowing that we had that HVP growth coming even if COVID went away. So we needed that capital in place.
It's for things like Annex 1, for just the normal growth rates we're seeing around biologics. So this year, the CapEx remains elevated. Over time, we expect it to normalize back to around that 6%-7% of revenues. But again, we have to make sure that we have the processes in place. And a lot of it is the investment is around adding additional process capacity around Envision PharmaWash to support conversions like the type of things that Annex 1 will drive. So on the HVP, in the past, what we would have seen, the conversion was really on people layering in new drugs. But with Annex 1, we'll actually be converting existing drugs to HVP or moving them up the HVP curve. So it will provide a little bit of acceleration to that over time. But again, it's not one standout event.
Yeah. I was just going to ask, have you made the necessary investments for the next 1-2 years of volumes expected from Annex 1?
Yeah. Those investments are done for the next 1-2 years. What we have to look out is past that nearly 2- to 3- or 4-year horizon, given the time it takes to get that capital equipment ordered and then delivered. So you're looking at 12- to 24-month timeframe. So we always have to be ahead of the curve. What we've actually built in is some headroom and capacity to allow us to flex more in the future rather than being so reactive to pretty large spikes in demand. We want to have the capacity in place so we can maintain our lead times and maintain consistent supply to our customers. I think over the last couple of years, we saw a spike in lead times throughout over 50 weeks in some instances. Now, we have brought that back down to more normalized lead time rates.
But again, that's something that we're trying to avoid in the future. So we're not getting this whipsaw effect.
Makes sense. On pricing, so you got, I guess, 5.5 points in 4Q. What are your assumptions there for 2024 and kind of walk through where you're able to get pricing? Obviously, the HVPs versus more componentized, but just any pushback and normalized rates.
Yeah. So this year, and it kind of ties in with what's in that long-term construct as well as like 2%-3% up price. I think last year was a bit the price get was a bit elevated based on we were trying to cover a lot of inflationary costs as well. So we're in a position to be able to pass some of that on to customers and be able to have those conversations. But on a kind of more normal operating model, we target that 2%-3%. And there are certain areas. It depends whether we have contracts in place with customers or if they're just going from purchase order to purchase order. You have to look at the ability to raise prices in different areas. So for us, we don't operate a price list.
So it's not a flat 2%-3% across the business. So we have greater flexibilities in some areas versus others.
All right. And within that, that's 2-3 on biologics, or should we expect a little bit more from mix in that LRP construct?
Again, it depends on how much of that business is contracted and then how much of it is also coming, like that's pure price. There's also the mix shift gain that we get when we move people up that high-value product curve. So we got to look at it in a couple of different ways.
Yeah. That's wonderful. I'm just trying to figure out because the patient volumes, the patient populations are getting smaller. Drugs are getting more complex. So some of the offsets that you have available to offset those lower volumes as you're thinking about that LRP and double-digit growth.
Yeah. But I think when we look at biologics, there is the ability to get more price there versus in our pharma business where we're dealing with a lot of standard products, and it's a little bit more price competitive. So that makes it more challenging. Again, so it's really looking at where is the value capture versus what we're providing to the customer.
Okay. Probably the last one here. So talk about the investment you guys made into the integrated systems in the wearables. As the drugs go from IV bags to subQ and expected IO patent cliffs and that, just give a sense of what you're doing there.
So two different things. So on the integrated systems, I think that goes under an overall push in the industry and by regulators to continue to raise the bar. And so there is a lot more scrutiny on devices like prefill syringes that they should operate like a true integrated system as opposed to what it is now, which is a bit more piecemeal. Customer picks an elastomer, a seal, a glass supplier, etc., and then puts it all together and calls it a system. What we envision is that if you actually have it fit for purpose where it's a dedicated elastomer glass system that has been validated with higher specs and higher reproducibility and reliability, we think that we can provide incremental value. With respect to the wearable side, that just follows the trend of how can you make healthcare more accessible?
Today, if you have a patient that has to travel to a clinic, to an infusion center, that's just a barrier for patients to adhere to the regimen. But if you can enable them to go and get treatment at their own home to have more self-care, now you can open up better adherence and better applications. And so as companies are able to reformulate and get it into volumes of 3-10 ccs, now it puts it within the realm of delivery devices like our SmartDose device, which can do bolus or basal delivery at a variety of times and again, just adds more value to the healthcare system.
Makes sense. All right. That's all we have. Thank you.
Thank you.