West Pharmaceutical Services, Inc. — 2010 Q2 Form 10-Q Summary
Business context and reporting period
West Pharmaceutical Services, Inc. filed its unaudited Form 10-Q for the quarter and six months ended June 30, 2010. The company manufactures pharmaceutical packaging components and delivery systems through two reportable segments: Packaging Systems and Delivery Systems. Segment comparisons were restated to reflect the organizational realignment effective January 1, 2010.
Key financial metrics
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Net sales | $281.8 million, versus $261.0 million | $556.5 million, versus $503.4 million |
| Gross profit | $83.2 million, versus $78.7 million | $165.4 million, versus $148.0 million |
| Gross margin | 29.5%, versus 30.2% | 29.7%, versus 29.4% |
| Operating profit | $30.5 million, versus $28.7 million | $59.4 million, versus $49.9 million |
| Net income | $21.7 million, versus $19.7 million | $41.6 million, versus $35.1 million |
| Diluted EPS | $0.62, versus $0.57 | $1.19, versus $1.03 |
| Operating cash flow | Not separately provided | $43.1 million, versus $46.1 million |
- Second-quarter sales increased 8.0%; constant-currency sales increased 10.2% after a $5.6 million unfavorable currency effect.
- Six-month sales increased 10.6%, including a favorable $4.2 million currency effect. Packaging Systems generated $399.8 million of sales, while Delivery Systems generated $158.9 million.
- Packaging Systems drove operating improvement, with segment operating profit of $37.6 million in the quarter and $77.4 million year to date. Delivery Systems operating profit declined to $3.6 million in the quarter and $4.8 million year to date.
- Second-quarter operating margin was approximately 10.8%, compared with 11.0% in the prior-year quarter. Six-month operating margin was approximately 10.7%, compared with 9.9%.
- Research and development expense increased to $5.7 million in the quarter and $11.1 million year to date. SG&A increased to $45.8 million and $92.4 million, respectively, but declined as a percentage of sales.
- Cash and cash equivalents were $67.5 million at June 30, 2010, compared with $83.1 million at December 31, 2009. Working capital was $245.3 million and the current ratio was 2.5 to 1.
- Total debt was $357.2 million, compared with $379.6 million at year-end; net debt-to-total invested capital was 33.7%.
- Capital expenditures were $32.6 million year to date, compared with $48.8 million in 2009. Management expected full-year 2010 capital spending to approximate 2009 spending of $104.9 million.
- Dividends paid were $10.7 million, or $0.32 per share, in the first half of 2010. A quarterly dividend of $0.16 per share was declared for payment in August 2010.
Material changes versus the prior comparable period
- Revenue growth reflected higher volume and favorable product mix, particularly for higher-value pharmaceutical packaging products, plus acquisition contributions.
- Packaging Systems’ quarterly gross margin improved to 33.6% from 33.1%; Delivery Systems’ margin declined to 19.1% from 21.9%.
- Delivery Systems’ margins were pressured by acquired business mix, lower average selling prices, higher raw-material and production costs, and an Eris safety syringe contract that generated sales but no gross profit.
- Foreign exchange reduced second-quarter revenue by $5.6 million and net income by approximately $1.1 million, or $0.03 per diluted share.
- Year-to-date operating cash flow declined $3.0 million despite higher earnings, primarily because of larger increases in accounts receivable and inventory. Inventory increased to $143.3 million from $129.2 million at year-end.
- Comprehensive income declined to a loss of $3.7 million for the first six months, versus income of $48.6 million in 2009, primarily due to a $45.3 million after-tax other comprehensive loss, including foreign currency translation effects.
- The effective tax rate for the first half increased to 24.6% from 20.0%, principally because 2009 included a $1.7 million tax benefit. Excluding discrete items, the estimated 2010 annual effective tax rate was 23.9%.
Guidance, outlook, risks, contingencies and unusual items
- Management expected sales growth to moderate in the second half of 2010 because of unfavorable foreign exchange and a strong 2009 comparison that included $22.0 million of non-recurring H1N1 vaccination-related sales.
- The company expected $0.5 million to $0.7 million of additional restructuring charges in the second half of 2010, with restructuring activities expected to be completed by year-end.
- A new multi-currency revolving credit facility was entered into in June 2010. It provides $225.0 million of committed capacity, expandable to $275.0 million; $19.2 million was outstanding at June 30, leaving $203.8 million available.
- The facility includes leverage and interest-coverage covenants. Management stated that liquidity was sufficient to fund operations, product development, capital expansion, pension obligations, dividends, debt repayment and potential acquisitions.
- Management identified risks from customer demand and product mix, competition, supply-chain interruptions, single-source suppliers, raw-material and petroleum costs, foreign exchange, interest rates, regulatory approvals, product liability, intellectual property, pension obligations, tax matters, healthcare legislation and economic conditions.
- The company maintained hedges for interest-rate, foreign-currency and petroleum-related risks. Interest-rate swaps effectively fixed rates on $75.0 million of notes at 5.32% and 5.51%; crude-oil options covered a portion of forecast elastomer purchases through December 2010.
- Restructuring and other items totaled $2.5 million in the first half, including $1.0 million of restructuring charges and $1.5 million of foreign-exchange losses and other items.
- Cash held in escrow for Brazilian tax matters was $11.8 million. Management estimated that $4.6 million of excess deposits could be returned over the following 12 months as tax cases were settled.
- The filing reported no significant changes to previously disclosed commitments, contingencies or risk factors and no material adverse effect expected from current legal proceedings.
- No explicit full-year revenue or earnings-per-share guidance was provided in the filing text.
Investor verification checklist
- Verify whether Packaging Systems’ volume and mix gains continue to offset foreign-exchange pressure and higher input costs.
- Monitor Delivery Systems’ margin recovery, particularly the profitability of the acquired Eris safety syringe business.
- Reconcile cash conversion against reported earnings as receivables and inventory remain elevated.
- Review compliance with the new revolving facility’s leverage and interest-coverage covenants.
- Track the remaining restructuring charges, Brazilian tax escrow recovery and potential $2.1 million reduction in unrecognized tax benefits.
- Assess the impact of the expected second-half sales moderation, including the absence of prior-year H1N1-related revenue.