West Pharmaceutical Services, Inc. — Form 10-Q Summary
Business context and reporting period
West manufactures packaging components, drug-delivery systems, and contract-manufactured devices for pharmaceutical, biotechnology, generic, diagnostic, and medical-device customers. Operations are reported through Proprietary Products and Contract-Manufactured Products. This filing covers the three and six months ended June 30, 2017, compared with the corresponding 2016 periods.
Beginning in the second quarter of 2017, the company excluded its Venezuelan subsidiary from consolidated results after determining it no longer controlled the subsidiary under U.S. GAAP.
Key financial metrics
| Metric | Three months ended June 30, 2017 | Three months ended June 30, 2016 | Six months ended June 30, 2017 | Six months ended June 30, 2016 |
|---|---|---|---|---|
| Net sales | $397.6 million | $388.0 million | $785.3 million | $750.1 million |
| Gross profit | $125.0 million | $133.3 million | $259.1 million | $256.6 million |
| Gross margin | 31.4% | 34.4% | 33.0% | 34.2% |
| Operating profit | $42.7 million | $61.2 million | $104.0 million | $91.2 million |
| Operating margin | 10.7% | 15.8% | 13.2% | 12.2% |
| Net income | $38.8 million | $44.7 million | $99.7 million | $66.9 million |
| Diluted earnings per share | $0.51 | $0.60 | $1.32 | $0.90 |
| Cash flow from operations | Not separately provided | Not separately provided | $106.0 million | $79.2 million |
Second-quarter sales increased 2.5% as reported and 3.9% excluding currency effects. Six-month sales increased 4.7% as reported and 6.2% excluding currency effects. Contract-Manufactured Products grew more rapidly than Proprietary Products, with second-quarter sales increases of 9.9% and 0.6%, respectively.
Second-quarter gross profit declined 6.2%, primarily because of unfavorable product mix and higher labor and overhead costs. Six-month gross profit increased 1.0%, but the gross margin declined 1.2 percentage points. Research and development expense increased 13.6% in the quarter and 11.5% year to date, reflecting continued investment in self-injection systems, advanced delivery research, and innovation.
Liquidity, debt, and capital allocation
- Cash and cash equivalents were $226.6 million at June 30, 2017, compared with $203.0 million at December 31, 2016.
- Working capital was $428.8 million, versus $400.9 million at year-end 2016.
- Total debt was $229.5 million, including $33.8 million classified as current and $195.7 million classified as long-term.
- The company had $268.6 million of available capacity under its $300.0 million multicurrency revolving credit facility after borrowings and letters of credit.
- Management stated that the company was in compliance with all debt covenants and expected cash, operating cash flow, and credit availability to satisfy foreseeable liquidity needs.
- Capital expenditures were $67.0 million in the first six months, including spending for new products, expansion, emerging markets, and the Waterford, Ireland facility.
- The company contributed $20.0 million to its U.S. qualified pension plan during the first six months.
- The company repurchased 325,000 shares for $26.9 million during the first six months and declared dividends of $0.26 per share.
Material changes versus the prior comparable period
- Six-month net income increased $32.8 million, primarily reflecting a $25.5 million tax benefit from adoption of new share-based-payment accounting guidance and lower 2017 restructuring-related charges.
- The second-quarter net income comparison was unfavorable despite higher sales: net income declined $5.9 million, largely because of the $11.1 million Venezuela deconsolidation charge and lower gross profit.
- The effective tax rate declined to 7.1% for the quarter and 5.1% year to date, from 28.6% and 27.4%, respectively. The 2017 rates benefited from share-based-payment tax benefits of $9.6 million for the quarter and $25.5 million year to date, as well as a $3.5 million benefit related to planned repatriation of approximately $65.0 million of foreign cash.
- Six-month operating profit increased 14.0%, while adjusted operating profit excluding unallocated items was essentially flat at $115.1 million versus $115.3 million in 2016. Adjusted operating margin declined to 14.7% from 15.4%.
- 2016 included $21.4 million of restructuring and related charges and a $2.7 million Venezuela currency-devaluation charge. The 2017 first half included an $11.1 million Venezuela deconsolidation charge instead.
- Foreign currency translation reduced reported six-month sales growth by $11.4 million and reduced reported second-quarter sales growth by $5.6 million.
Outlook, commentary, risks, and unusual items
The filing does not provide specific consolidated revenue or earnings guidance. Management expects cash on hand, operating cash generation, and revolver availability to support foreseeable liquidity requirements. Approximately $65.0 million of cash held by non-U.S. subsidiaries was planned for repatriation during 2017.
- Key operating risks include customer demand and inventory changes, competition and pricing pressure, regulatory approval and commercialization of customer products, product mix, production efficiency, skilled-labor availability, supply-chain interruptions, single-source suppliers, and rising petroleum-based raw-material costs.
- Foreign exchange exposure is significant, particularly involving the euro, yen, Singapore dollar, and other currencies. The company uses currency contracts, debt-designated net-investment hedges, and interest-rate swaps.
- SmartDose contingent consideration was $8.5 million at June 30, 2017. Its valuation depends on sales projections, probability of success, and discount rates and could change materially.
- The company held crude-oil call options covering 43,875 barrels at June 30, 2017 to mitigate exposure to elastomer surcharges.
- Future minimum payments under non-cancelable operating leases were $71.8 million. The filing reports no material changes to previously disclosed commitments or contingencies and no material off-balance-sheet financing arrangements beyond ordinary-course leases, purchase obligations, and letters of credit.
- Management stated that current legal proceedings are not expected to have a material adverse effect, although outcomes cannot be predicted with certainty.
- Disclosure controls and procedures were assessed as effective as of June 30, 2017, with no material changes to internal control over financial reporting.
Important facts for investors to verify
- Whether gross-margin pressure from product mix, labor, and overhead costs persists despite continued sales growth.
- The sustainability of reported earnings growth after excluding the 2017 share-based-payment tax benefits and comparing unusual Venezuela and restructuring items.
- The timing and funding of the $33.7 million term loan due January 2018 and the company’s ability to maintain current liquidity.
- Progress and returns from the Waterford, Ireland expansion and other capital projects.
- The commercial timing, regulatory progress, and valuation assumptions supporting SmartDose and other delivery-system investments.
- The effect of foreign currency movements, raw-material costs, customer ordering patterns, and global healthcare regulation on future results.