West Pharmaceutical Services, Inc. — Form 10-Q Summary
Reporting period: Three months ended March 31, 2013; filed May 6, 2013. The interim financial statements are unaudited and should be read with the 2012 Form 10-K.
Business Context
West operates through two segments: Packaging Systems, which provides primary packaging components for injectable drug delivery, and Delivery Systems, which provides safety, administration, proprietary drug-delivery and contract-manufacturing systems. Operations are global, with significant sales and cash held outside the United States.
Financial Performance
| Metric | Q1 2013 | Q1 2012 | Change |
|---|---|---|---|
| Net sales | $339.4 million | $316.3 million | +7.3% |
| Gross profit | $111.7 million | $101.1 million | +10.5% |
| Gross margin | 32.9% | 31.9% | +1.0 percentage point |
| Operating profit | $43.3 million | $41.7 million | +3.8% |
| Income before taxes | $39.1 million | $37.8 million | +3.4% |
| Net income | $31.7 million | $29.2 million | +8.6% |
| Diluted EPS | $0.90 | $0.81 | +$0.09 |
| Operating cash flow | $18.9 million | $13.8 million | +$5.1 million |
Sales growth reflected favorable product mix, pricing and demand. U.S. sales increased 5.9% to $150.6 million, while non-U.S. sales increased 8.4% to $188.8 million. Excluding currency effects, consolidated sales increased 7.2%.
- Packaging Systems: Sales increased 6.7% to $251.5 million; operating profit increased 9.3% to $58.6 million; gross margin rose to 37.7% from 36.1%.
- Delivery Systems: Sales increased 9.2% to $88.2 million; operating profit declined 47.8% to $1.2 million; gross margin decreased to 19.1% from 19.7%.
- Expenses: R&D increased 9.6% to $9.1 million, and SG&A increased 15.2% to $59.1 million. SG&A rose to 17.4% of sales from 16.2%, partly due to compensation, information technology, legal, intellectual-property and other corporate costs.
- Tax rate: The effective rate declined to 22.0% from 26.1%, primarily due to a $1.3 million discrete benefit from the retroactive reinstatement of the U.S. research and development tax credit.
Cash Flow, Debt and Liquidity
| Balance-sheet metric | March 31, 2013 | December 31, 2012 |
|---|---|---|
| Cash and cash equivalents | $175.0 million | $161.9 million |
| Short-term investments | $8.2 million | $12.4 million |
| Working capital | $381.6 million | $295.5 million |
| Total debt | $430.1 million | $411.5 million |
| Total equity | $745.9 million | $728.9 million |
| Net debt-to-total invested capital | 25.5% | 25.5% |
- Investing cash outflows were $57.7 million, including $61.7 million of capital expenditures, primarily for the new corporate office and research building, information technology infrastructure and a new compression-molding plant in China.
- Financing cash inflows were $55.5 million. The company borrowed $42.8 million for the new building, refinanced a maturing Euro note through its multi-currency revolver and repaid $1.7 million of convertible debentures.
- The multi-currency revolving credit facility had $113.8 million outstanding and $182.6 million of available borrowing capacity at March 31, 2013. The company stated that it was in compliance with all debt covenants.
- Cash held by non-U.S. subsidiaries totaled $162.3 million and could create additional U.S. tax obligations if repatriated, although short-term intercompany loans may provide access without immediate U.S. income tax.
- Management believes cash, operating cash flow and available revolving-credit capacity will meet foreseeable liquidity needs.
Material Changes and Unusual Items
- Gross-margin improvement was driven by favorable product mix, price increases and production efficiencies, partly offset by higher raw-material, wage and benefit costs.
- Operating profit benefited from lower restructuring and other charges and approximately $0.3 million of development income, but was offset in part by higher operating expenses and an approximately $0.7 million charge related to the Venezuelan bolivar devaluation.
- The company recorded a $0.2 million loss on debt extinguishment from repurchasing $1.7 million of convertible debentures.
- Restructuring obligations were $1.3 million at March 31, 2013, with payments expected to be completed by the end of 2013. The company does not expect additional charges under the 2010 restructuring plan.
- Comprehensive income fell to $15.1 million from $42.2 million, primarily because of an $18.4 million after-tax foreign-currency translation loss.
- Inventory increased to $173.5 million from $162.2 million, and accounts receivable increased to $189.0 million from $175.0 million, reflecting higher sales and order activity.
Outlook, Risks and Contingencies
Management expects continued revenue improvement from customers moving toward higher-value Packaging Systems products and growth in proprietary Delivery Systems products. Priorities include high-value closure products, Crystal Zenith-based containment systems, proprietary delivery systems, capacity expansion, cost reduction, lean initiatives and emerging-market investment. The filing does not provide specific quarterly or annual revenue or earnings guidance.
- Key risks include demand volatility, customer inventory changes, competition and pricing pressure, regulatory approval and commercialization of customer products, and the timing of new-product adoption.
- Raw-material and petroleum-related costs, supply-chain interruptions, reliance on third-party and single-source suppliers, labor availability, production execution and foreign-exchange movements may affect results.
- SmartDose contingent consideration was $3.3 million. Its value depends on sales projections and discount rates and could change as commercialization progresses.
- The company uses interest-rate, foreign-exchange and commodity hedges; variable-rate debt and international operations remain exposed to market fluctuations.
- Management reported no material changes to previously disclosed legal proceedings, commitments, contingencies or risk factors and believes current proceedings will not materially adversely affect the company.
- No material off-balance-sheet financing arrangements were reported other than operating leases, ordinary-course purchase obligations and insurance-related letters of credit.
Investor Verification Priorities
- Verify whether Packaging Systems growth and margin expansion continue to offset weaker Delivery Systems profitability.
- Track conversion of elevated capital spending into capacity, revenue and operating-cash-flow growth, particularly at the China plant and new office and research facility.
- Assess leverage, variable-rate exposure, revolver utilization and covenant headroom following the new borrowings and Euro note refinancing.
- Separate recurring earnings performance from the $1.3 million tax benefit, $0.2 million debt-extinguishment loss, development income and currency-related items.
- Monitor foreign-currency translation, raw-material costs, Venezuelan currency exposure and cash held by non-U.S. subsidiaries.
- Evaluate regulatory and commercialization milestones for Crystal Zenith, SmartDose and other proprietary delivery systems.