West Pharmaceutical Services, Inc. — 2014 Third-Quarter Form 10-Q
Reporting period: Three and nine months ended September 30, 2014; unaudited interim results. West operates through Pharmaceutical Packaging Systems and Delivery Systems, serving injectable drug packaging, drug-delivery systems, proprietary products, and contract manufacturing markets.
Financial Results and Position
| Metric | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|---|---|---|---|
| Net sales | $355.9 million | $341.8 million | $1,071.6 million | $1,025.7 million |
| Gross profit | $109.9 million | $105.5 million | $338.1 million | $328.1 million |
| Gross margin | 30.9% | 30.8% | 31.5% | 32.0% |
| Operating profit | $44.0 million | $39.7 million | $137.4 million | $125.5 million |
| Operating margin | 12.4% | 11.6% | 12.8% | 12.2% |
| Net income | $31.0 million | $26.8 million | $95.7 million | $88.7 million |
| Diluted EPS | $0.43 | $0.37 | $1.32 | $1.25 |
- Q3 sales increased 4.1%; constant-currency sales increased 4.2%. Nine-month sales increased 4.5%, including a $9.3 million favorable currency effect, or 3.6% excluding currency.
- Delivery Systems was the principal growth driver: Q3 sales rose 14.9% and nine-month sales rose 9.9%. Proprietary products represented 27.4% of Q3 Delivery Systems sales versus 23.6% in the prior year.
- Packaging Systems sales were essentially flat in Q3, up 2.4% for the nine months. Its operating profit declined 3.3% in Q3 and 1.7% year to date, primarily reflecting higher wages, benefits, and other costs.
- Q3 net income benefited from higher gross profit, lower incentive compensation and lower U.S. pension expense. Q3 effective tax rate was 28.2%, compared with 29.7% in 2013; the nine-month rate was 27.8%, compared with 25.9%.
- Net cash provided by operating activities was $136.9 million versus $151.7 million in the prior-year period. The decline primarily reflected the $20.0 million SmartDose customer payment received in 2013.
- Capital expenditures were $84.8 million versus $113.1 million. Net cash used in investing activities was $77.7 million, compared with $111.0 million.
- Cash and cash equivalents were $246.8 million at September 30, 2014, compared with $230.0 million at December 31, 2013. Working capital was $437.0 million.
- Total debt was $342.7 million, down from $373.5 million at year-end; long-term debt was $315.5 million and current debt was $27.2 million. Net debt-to-total invested capital improved to 9.0% from 13.7%.
- The company had $265.3 million of available borrowing capacity under its $300.0 million multi-currency revolving credit facility, after outstanding borrowings and letters of credit. West was in compliance with all debt covenants.
Material Changes Versus Prior Comparable Period
- Q3 operating profit increased 10.8%, and diluted EPS increased 16.2%. Nine-month operating profit increased 9.5%, and diluted EPS increased 5.6%.
- Delivery Systems moved from a $0.1 million operating loss in Q3 2013 to $4.8 million of operating profit in Q3 2014; nine-month operating profit rose from $3.4 million to $8.3 million.
- Consolidated SG&A declined 0.2% in Q3 and 2.9% year to date, primarily due to lower incentive compensation and pension costs at Corporate.
- Foreign currency translation produced a $38.9 million after-tax reduction in other comprehensive income for the nine months, leaving accumulated other comprehensive loss of $71.3 million.
- Gross margin improved slightly in Q3 but declined year to date, mainly due to cost pressures in Packaging Systems.
Outlook, Commentary, Risks, and Unusual Items
- Management expects long-term revenue and margin improvement from demand for higher-quality products, increased mix of proprietary Delivery Systems products, capacity expansion, restructuring and lean initiatives, and emerging-market investments. No specific quantitative earnings or revenue guidance was provided.
- West plans continued capital investment in new products, expansion, quality systems, emerging markets, and proprietary delivery products. A new pharmaceutical component facility in Waterford, Ireland was planned, subject to planning and zoning approvals, with construction expected to begin in early 2015.
- The Board authorized a common-stock repurchase program of up to $100.0 million on October 29, 2014, expected to be completed no later than December 31, 2015.
- Chief Executive Officer Donald E. Morel announced plans to retire at the May 2015 annual meeting; the Board began a successor search.
- Q3 included a $1.2 million license-cost charge associated with acquired in-process research. SmartDose contingent consideration increased by $1.0 million year to date, and the related liability was $5.1 million at September 30.
- Unearned income related to a prior $20.0 million SmartDose customer payment was $17.8 million at quarter-end. The agreement has no future minimum purchase commitment.
- Key risks include customer demand and inventory changes, competition and pricing pressure, regulatory approval and commercialization of customer products, product mix, supply-chain and single-source supplier dependence, raw-material costs, foreign exchange exposure, skilled-labor availability, product development execution, and healthcare legislation.
- West reported no material changes to previously disclosed risk factors or commitments and contingencies. No material legal proceedings were reported. Management concluded that disclosure controls were effective.
- At September 30, 2014, the company held $231.1 million of cash outside the United States, and repatriation could create additional U.S. tax obligations. A potential future charge of up to $2.1 million could arise from Venezuelan currency devaluation or use of an alternative exchange mechanism.
Investor Verification Checklist
- Verify whether Delivery Systems growth, particularly SmartDose, proprietary products, and contract manufacturing, continued without relying on the one-time nature of prior customer payments.
- Assess whether Packaging Systems margin pressure from wages, benefits, overhead, and raw materials offset pricing and productivity gains.
- Reconcile operating cash flow with net income, capital expenditures, debt repayments, dividends, and the absence of the prior-year $20.0 million customer payment.
- Review debt maturities, including the $25.0 million Series B notes due in 2015, available revolver capacity, interest-rate hedges, and covenant compliance.
- Evaluate the effects of foreign exchange movements on sales, comprehensive income, debt, cash held overseas, and the Venezuelan subsidiary.
- Monitor the $100.0 million repurchase authorization, planned Ireland facility, CEO succession, SmartDose contingent consideration, and regulatory or commercialization milestones.