West Pharmaceutical Services, Inc. — Q3 2011 Form 10-Q Summary
Business context and reporting period
West Pharmaceutical Services manufactures pharmaceutical packaging components and drug-delivery systems through two reportable segments: Pharmaceutical Packaging Systems and Pharmaceutical Delivery Systems. This unaudited Form 10-Q covers the three and nine months ended September 30, 2011, compared with the corresponding 2010 periods.
Financial performance and liquidity
| Metric | Q3 2011 | Q3 2010 | 9M 2011 | 9M 2010 |
|---|---|---|---|---|
| Net sales | $293.6 million | $271.4 million | $896.9 million | $827.9 million |
| Gross profit | $81.4 million | $74.7 million | $254.0 million | $240.1 million |
| Gross margin | 27.7% | 27.5% | 28.3% | 29.0% |
| Operating profit | $26.1 million | $25.3 million | $82.6 million | $84.8 million |
| Operating margin | 8.9% | 9.3% | 9.2% | 10.2% |
| Net income | $16.9 million | $17.8 million | $56.7 million | $59.3 million |
| Diluted EPS | $0.49 | $0.51 | $1.62 | $1.70 |
Q3 sales increased 8.2%, including a $12.7 million favorable foreign-exchange effect; constant-currency sales increased 3.5%. Nine-month sales increased 8.3%, or 4.5% excluding currency. Packaging Systems drove growth, while Delivery Systems experienced margin pressure from contractual price reductions and higher raw-material costs.
For the nine months, operating cash flow was $88.9 million versus $91.1 million in 2010. Capital expenditures were $62.0 million versus $49.8 million, implying operating cash flow less capital expenditures of approximately $26.9 million, compared with approximately $41.3 million in the prior-year period. Investing cash flow was $(84.2) million, including $22.8 million of net short-term investment purchases. Financing cash flow was $3.4 million, including $17.1 million of dividend payments.
At September 30, 2011, cash and cash equivalents were $119.2 million, short-term investments were $23.6 million, working capital was $274.2 million, and total debt was $378.0 million. Net debt-to-total invested capital was 27.2%, compared with 28.4% at December 31, 2010. The Company had $192.8 million of availability under its $225.0 million revolving facility and no borrowings under the new $50.0 million facility. Management reported compliance with all debt covenants.
Material changes versus the prior comparable period
- Q3 gross profit rose 9.0%, and gross margin improved 20 basis points; nine-month gross margin declined 70 basis points because of raw-material, wage, benefit and depreciation costs.
- Q3 operating profit increased 3.2%, but nine-month operating profit declined 2.6% as higher R&D, SG&A and restructuring costs offset gross-profit growth.
- R&D expense increased to $7.7 million in Q3 and $21.9 million for nine months, primarily due to SmartDose and advanced packaging and injection-system development.
- Effective tax rates increased to 30.0% for Q3 and 25.7% for nine months, from 21.3% and 23.6%, respectively, due to tax-law changes, discrete items and geographic earnings mix.
- Packaging Systems Q3 sales increased 9.2% and operating profit increased to $34.8 million; Delivery Systems Q3 sales increased 4.2%, but operating profit declined to $1.7 million from $3.6 million.
- Foreign-currency translation produced a $25.1 million after-tax other comprehensive loss in Q3, contributing to Q3 comprehensive loss of $7.0 million despite net income of $16.9 million.
Guidance, outlook, risks and unusual items
- Management expected 2011 capital spending of $115 million to $120 million, versus $71.1 million in 2010, primarily for capacity expansion and facility projects.
- The Company forecast 2011 gross margins slightly below 2010 levels. Selling-price increases and a temporary raw-material surcharge, effective through year-end, were expected to partially offset higher input costs.
- The December 2010 restructuring plan is expected to generate total charges of approximately $22 million to $24 million through 2012. The Company incurred $4.3 million during the first nine months of 2011 and expected approximately $3.0 million in additional Q4 2011 charges.
- The Company expects approximately $66 million of construction and development costs for a new corporate office and research building, with acquisition expected by Q1 2013. Additional direct building-related capital expenditures were estimated at $28.6 million over the following 18 months.
- Revised demand projections for the eris, Confidose and NovaGuard product lines triggered an impairment review; no impairment charge was recorded because projected cash flows exceeded carrying values.
- Key risks include raw-material and petroleum-based cost inflation, the ability to pass costs to customers, foreign-exchange movements, customer demand and inventory changes, regulatory and commercial success of customer products, supply-chain dependence, competition, restructuring execution, and delays in product development or approvals.
- The filing reports no material changes to previously disclosed legal proceedings or risk factors. Management concluded that disclosure controls were effective as of September 30, 2011.
Important facts for investors to verify
- Whether pricing actions and the temporary surcharge offset continuing rubber, polymer and resin inflation.
- The timing and return on the elevated capital-spending program, including Daikyo Crystal Zenith capacity and the China facility.
- Progress, final cost and cash requirements for the restructuring plan and new corporate office and research building.
- Demand, regulatory progress and impairment risk for SmartDose, eris, Confidose and NovaGuard.
- The maturity and refinancing requirements for the $50.0 million Series A Note due July 2012 and the Company’s ongoing compliance with leverage and interest-coverage covenants.
- The effect of foreign-exchange movements and the concentration of $115.5 million of cash outside the United States.