Business Context and Reporting Period
West Pharmaceutical Services, Inc. filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2018. West manufactures containment, packaging, drug-delivery and contract-manufacturing products for biologic, generic, pharmaceutical, diagnostic and medical-device customers. Reportable segments are Proprietary Products and Contract-Manufactured Products.
Financial Highlights
| Metric | Q3 2018 | Q3 2017 | Nine Months 2018 | Nine Months 2017 |
|---|---|---|---|---|
| Net sales | $431.7 million | $398.2 million | $1,294.9 million | $1,183.5 million |
| Gross profit | $135.6 million | $125.1 million | $412.2 million | $384.3 million |
| Gross margin | 31.4% | 31.4% | 31.8% | 32.5% |
| Operating profit | $60.8 million | $62.9 million | $174.5 million | $165.4 million |
| Operating margin | 14.1% | 15.8% | 13.5% | 14.0% |
| Net income | $55.2 million | $51.0 million | $154.9 million | $150.7 million |
| Diluted earnings per share | $0.73 | $0.67 | $2.05 | $1.99 |
Q3 sales increased 8.4% year over year, or 9.6% excluding foreign-currency translation. Nine-month sales increased 9.4%, or 6.3% excluding currency effects. Proprietary Products sales rose 5.2% in the quarter and 7.2% year to date; Contract-Manufactured Products sales rose 19.5% and 17.6%, respectively.
Q3 operating profit declined 3.3% despite higher sales, reflecting lower other income, restructuring charges, the Argentina inflation-related charge and higher corporate costs. Nine-month operating profit increased 5.5%. Adjusted operating profit, excluding unallocated items, increased to $63.1 million in Q3 and $182.3 million year to date, but adjusted margins declined to 14.6% and 14.1%, respectively, from 15.8% and 14.9%.
Cash Flow, Liquidity and Capital Structure
- Operating cash flow was $215.4 million for the nine months, compared with $181.8 million in the prior-year period.
- Investing cash flow was a use of $72.2 million, including $74.7 million of capital expenditures, versus $104.2 million used in the prior year.
- Financing cash flow was a use of $72.5 million, including $31.0 million of dividends and $70.8 million for repurchases of 800,000 shares.
- Cash and cash equivalents were $297.3 million at September 30, 2018, compared with $235.9 million at December 31, 2017. Approximately $190.7 million was held outside the United States.
- Working capital was $561.3 million, versus $464.0 million at year-end 2017.
- Total debt was $196.2 million, substantially unchanged from $197.0 million at year-end. The $300.0 million revolving credit facility had $268.8 million of available capacity after borrowings and letters of credit.
- Management stated that the Company was in compliance with its debt covenants and expects cash, operating cash flow and credit availability to meet foreseeable liquidity needs.
Material Changes Versus the Prior Comparable Period
- Revenue growth was led by higher-value Proprietary Products and strong Contract-Manufactured Products volume, particularly in Ireland. Contract-Manufactured Products also benefited from price increases but faced plant-consolidation overhead, program start-up costs and higher raw-material costs.
- Consolidated gross margin was flat in Q3 but declined 70 basis points for the nine months. Proprietary Products margin improved, while Contract-Manufactured Products margin declined 200 basis points in Q3 and 250 basis points year to date.
- Q3 results included $1.2 million of restructuring charges and a $1.1 million charge related to Argentina’s classification as highly inflationary. Nine-month results included $6.7 million of restructuring charges and the same $1.1 million Argentina charge.
- Prior-year comparisons included $9.1 million of technology-license cost reimbursement income in Q3 2017 and an $11.1 million Venezuela deconsolidation charge in the first nine months of 2017.
- The Company adopted ASC 606 revenue recognition effective January 1, 2018, using the modified retrospective method. The adoption increased retained earnings by $11.4 million and affected the timing and classification of revenue, assets and liabilities; prior periods were not recast.
- Tax expense was $8.0 million in Q3, producing a 13.1% effective tax rate, versus 22.3% in the prior-year quarter. The quarter included a $7.7 million tax benefit related to share-based compensation accounting. The nine-month effective tax rate was 15.1%, versus 11.7% in 2017.
Guidance, Outlook, Commentary and Risks
The filing does not provide a formal full-year revenue or earnings-per-share guidance range. Management expects the restructuring plan, approved in February 2018 and scheduled for implementation over 12 to 24 months, to require total restructuring and related charges of $8.0 million to $13.0 million and capital expenditures of $9.0 million to $14.0 million. Once completed, the plan is expected to generate annualized savings of $17.0 million to $22.0 million.
The Waterford, Ireland facility began commercial production during Q3. Management continues to invest in self-injection systems, elastomeric packaging components and formulation development. Key risks include customer demand and ordering changes, regulatory approval and commercialization of customer products, product mix, manufacturing efficiency and overhead absorption, raw-material and petroleum-related costs, supply-chain and single-source supplier dependence, skilled-labor availability, foreign-exchange movements, competition, cybersecurity or operational disruptions, and global healthcare legislation.
Legal proceedings are described as incidental to normal business activities, with no expected material adverse effect. The filing reports no significant changes to previously disclosed commitments and contingencies and no material changes to reported risk factors.
Important Facts for Investors to Verify
- Confirm the sustainability of sales growth after separating volume, pricing, mix, foreign-currency translation and ASC 606 timing effects.
- Monitor Contract-Manufactured Products margins, Waterford ramp-up costs, plant-consolidation impacts and raw-material inflation.
- Track remaining restructuring charges and capital spending against the $8.0 million-$13.0 million and $9.0 million-$14.0 million estimates, respectively.
- Assess the recurring tax rate excluding share-based compensation benefits and 2017 Tax Act adjustments.
- Review cash held outside the United States, currency exposure, derivative positions and the ability to repatriate funds.
- Evaluate the effect of share repurchases and dividends on capital allocation and liquidity.
- Reconcile reported revenue and earnings with pre-ASC 606 amounts, recognizing that prior-year periods were not recast.