Business Context and Reporting Period
West Pharmaceutical Services, Inc. filed an unaudited Form 10-Q for the quarter and six months ended June 30, 2013. The company operates through two segments: Pharmaceutical Packaging Systems, which provides packaging components for injectable drug delivery, and Delivery Systems, which develops drug-administration systems and contract-manufacturing solutions.
Financial Performance and Liquidity
| Metric | Three Months Ended June 30 | Six Months Ended June 30 |
|---|---|---|
| Net sales | $344.5 million, up 6.1% | $683.9 million, up 6.7% |
| Gross profit | $110.9 million, up 12.4% | $222.6 million, up 11.4% |
| Gross margin | 32.2%, versus 30.4% | 32.6%, versus 31.2% |
| Operating profit | $42.5 million, up 19.4% | $85.9 million, up 11.1% |
| Net income | $30.2 million, up 93.6% | $61.9 million, up 38.0% |
| Diluted earnings per share | $0.86, versus $0.45 | $1.76, versus $1.27 |
| Operating cash flow | Not separately provided | $98.4 million, versus $66.0 million |
Packaging Systems generated second-quarter sales of $251.5 million, up 6.7%, while Delivery Systems generated $93.3 million, up 4.7%. Packaging Systems operating profit increased to $56.8 million from $50.5 million. Delivery Systems operating profit declined to $2.3 million from $5.5 million, primarily because of lower development income.
Six-month investing cash outflows were $81.9 million, including $83.8 million of capital expenditures. Financing activities provided $15.3 million, and cash increased to $190.6 million from $161.9 million at December 31, 2012. Working capital was $394.6 million versus $295.5 million at year-end.
Total debt was $394.8 million at June 30, 2013, compared with $411.5 million at December 31, 2012. Net debt-to-total invested capital improved to 20.7% from 25.5%. The company had $218.9 million of available borrowing capacity under its multi-currency revolving credit facility and stated that it was in compliance with all debt covenants.
Material Changes Versus the Prior Comparable Period
- Sales growth reflected higher volumes, increased demand for higher-value pharmaceutical packaging products, price increases, and favorable foreign exchange effects.
- Gross-margin expansion was driven mainly by improved production efficiencies; higher wages, benefits, and other costs partially offset the benefit.
- Second-quarter 2013 results benefited from the absence of the $11.6 million pretax debt-extinguishment loss recorded in the second quarter of 2012, as well as the absence of the prior-year $3.4 million impairment charge and restructuring charges.
- Delivery Systems operating profit declined materially because development income fell to $0.5 million in the quarter from $3.8 million in the prior-year period.
- Research and development expense increased 15.9% in the quarter and 12.7% for the six-month period, including investment in SmartDose and SelfDose.
- The effective tax rate declined to 26.5% for the quarter and 24.2% for the six months, compared with 32.7% and 28.4%, respectively, in 2012. The six-month period included a $1.3 million discrete tax benefit from the reinstated research and development tax credit.
- The company received a $20.0 million nonrefundable customer payment for exclusive use of SmartDose in a specified therapeutic area. Most of the payment remains deferred and is being recognized over thirteen years; the agreement has no future minimum purchase commitment.
Guidance, Outlook, Risks, and Unusual Items
Management did not provide specific full-year numerical earnings or revenue guidance in the filing. It expects continued revenue improvement from higher-value Packaging Systems products, proprietary Delivery Systems products, including SmartDose and CZ-based containment systems, capacity expansions, lean-cost initiatives, and emerging-market growth. Management expects to continue funding capital projects for new products, capacity expansion, and emerging markets.
Key risks include customer demand and order-pattern changes, competition and pricing pressure, regulatory approval and commercialization of customer products incorporating West systems, reliance on third-party suppliers including Daikyo, supply-chain disruptions, raw-material and petroleum-related costs, foreign-exchange movements, execution of production-efficiency initiatives, development and regulatory risks for new products, and potential effects of U.S. healthcare legislation.
SmartDose contingent consideration was $3.5 million at June 30, 2013 and is sensitive to changes in sales projections and discount rates. The company had $138.0 million of pension and other postretirement benefit liabilities. Remaining restructuring obligations were $0.2 million and were expected to be paid by year-end 2013. The company stated that current legal proceedings and contingencies are not expected to have a material adverse effect, and that there were no significant changes to prior-year commitments and contingencies.
After quarter-end, the board approved a two-for-one stock split payable September 26, 2013. Reported historical share and per-share data in the filing had not yet been adjusted for the split.
Important Facts for Investors to Verify
- Whether Packaging Systems growth and margin improvement continue after the reported efficiency gains and price increases.
- Whether Delivery Systems can replace lower prior-year development income with recurring proprietary-product revenue and successful SmartDose commercialization.
- The timing and return on the $83.8 million of first-half capital expenditures, including facilities in India, China, and the new corporate and research building.
- The availability and terms of the company’s revolving credit facilities, variable-rate exposure, currency exposure, and compliance with debt covenants.
- The sustainability of the lower effective tax rate, including the effect of discrete tax benefits and potential reductions in unrecognized tax benefits.
- The deferred-revenue terms and lack of a minimum purchase commitment under the $20.0 million SmartDose exclusivity agreement.
- The impact of foreign exchange, raw-material costs, supply-chain constraints, regulatory approvals, and customer product commercialization on future results.