West Pharmaceutical Services, Inc. — FY2017 Form 10-K Summary
Business context and reporting period
West is a global manufacturer of injectable-drug containment, packaging, delivery and administration systems, analytical laboratory services, and contract-manufactured devices. Operations are reported through Proprietary Products and Contract-Manufactured Products. The filing covers the fiscal year ended December 31, 2017, and was filed February 26, 2018. International sales represented 54.1% of consolidated net sales, and approximately 7,500 employees were employed worldwide.
Financial performance and position
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Net sales | $1,599.1 million | $1,509.1 million | +6.0% |
| Gross profit | $512.6 million | $501.1 million | +2.3% |
| Gross margin | 32.1% | 33.2% | -1.1 points |
| Operating profit | $228.9 million | $196.8 million | +16.3% |
| Operating margin | 14.3% | 13.0% | +1.3 points |
| Net income | $150.7 million | $143.6 million | +4.9% |
| Diluted EPS | $1.99 | $1.91 | +4.2% |
| Operating cash flow | $263.3 million | $219.4 million | +20.0% |
| Capital expenditures | $130.8 million | $170.2 million | -$39.4 million |
| Cash and equivalents | $235.9 million | $203.0 million | +$32.9 million |
| Total debt | $197.0 million | $228.6 million | -$31.6 million |
Proprietary Products generated $1,236.9 million of sales, up 3.9%, while Contract-Manufactured Products generated $362.5 million, up 13.2%. Contract-Manufactured Products operating profit increased 26.4% to $48.3 million; Proprietary Products operating profit was essentially flat at $242.2 million. Adjusted operating profit, excluding unallocated items, was $240.0 million, or a 15.0% margin, compared with $223.8 million and 14.8% in 2016.
Working capital increased to $464.0 million from $400.9 million, primarily reflecting higher receivables and currency effects. The company had $267.5 million of available capacity under its $300.0 million revolving credit facility, was in compliance with debt covenants, and stated that liquidity should be adequate for foreseeable needs. Total contractual obligations were $412.8 million, including debt, interest, leases, purchase obligations and other long-term liabilities.
Material changes versus the prior comparable period
- Sales growth was supported by favorable foreign currency translation of $12.2 million. Constant-currency sales growth was 5.2%.
- Proprietary Products growth slowed as customers worked down inventory purchased in 2016; improved production capacity and lead times supported renewed biologics and generics growth.
- Contract-Manufactured Products benefited from the commercial ramp-up of projects initiated in the second half of 2016.
- Consolidated gross margin declined because higher material, labor and overhead costs more than offset production efficiencies and price increases in Proprietary Products.
- The company repaid $33.1 million of its term loan in October 2017 and reduced total debt by $31.6 million year over year.
- Cash flow improved, while capital spending declined as major projects, including portions of the Waterford, Ireland facility, were completed. Commercial production at Waterford was expected in the second half of 2018.
- The company repurchased 800,000 shares for $74.4 million during 2017 and declared dividends of $0.54 per share, compared with $0.50 in 2016.
Guidance, outlook, risks and unusual items
The filing does not provide a clear numerical 2018 sales or earnings guidance figure. Management expects cash on hand, operating cash flow and revolving-credit availability to fund foreseeable liquidity requirements. A February 2018 restructuring plan is expected to be implemented over 12 to 24 months, require $8.0 million to $13.0 million of charges and $9.0 million to $14.0 million of capital expenditures, and generate annualized savings of $17.0 million to $22.0 million once completed. A new 2018 repurchase program authorizes purchases of up to 800,000 shares.
- Tax Act: The 2017 effective tax rate increased to 36.4% from 28.7%, including a $48.8 million discrete charge related to the 2017 Tax Act and international tax-rate changes. The company also recorded a $33.1 million tax benefit from adopting share-based payment accounting guidance. Tax impacts were provisional and could change.
- Venezuela: West recorded an $11.1 million charge for deconsolidating its Venezuelan subsidiary as of April 1, 2017. Future results exclude that subsidiary, and political and economic conditions remain uncertain.
- Licensing and contingent consideration: Development and licensing income was $10.6 million in 2017, including $9.1 million of reimbursed costs related to technology subsequently licensed to a third party. SmartDose contingent consideration was $4.9 million at year-end and could range from zero to $5.5 million over the next five years based on estimated probable payments.
- Operating risks: Key exposures include foreign exchange, raw-material and energy prices, single-source suppliers, manufacturing disruptions, regulatory approval and customer commercialization, product liability, cybersecurity, healthcare-policy changes, pricing pressure and pharmaceutical-industry consolidation.
- International and concentration risks: The ten largest customers represented 37.5% of sales, although no individual customer exceeded 10%. Daikyo provides important licensed technologies and accounted for a 25% ownership interest.
- Pension and other obligations: Pension plans were underfunded by $48.5 million and other postretirement benefits were underfunded by $7.1 million at year-end. Expected 2018 pension and other-retirement-benefit contributions totaled approximately $2.5 million.
- Accounting changes: The company adopted new guidance affecting share-based payment tax benefits and intra-entity asset transfers. The new revenue-recognition standard was expected to require a cumulative-effect adjustment in 2018, although management expected no material overall financial-statement impact.
Most important facts for investors to verify
- Whether the 2018 restructuring delivers the projected $17.0 million to $22.0 million of annual savings and whether charges and capital spending remain within the stated ranges.
- Underlying Proprietary Products demand, customer inventory normalization, backlog conversion and the effect of pricing and cost inflation on gross margin.
- Commercial ramp-up and profitability of Contract-Manufactured Products and the timing of Waterford production.
- The recurring tax rate after the 2017 Tax Act and the final resolution of provisional tax accounting, including the $9.8 million estimated withholding and state-tax liability.
- Foreign currency, Venezuela-related developments, raw-material prices and the effectiveness of hedging activities.
- Debt maturities, covenant compliance, cash generation, capital expenditures and the pace of share repurchases and dividends.
- Potential variability in SmartDose contingent consideration, licensing income and other non-recurring items.
- The filing reports effective disclosure controls and internal control over financial reporting, with no material legal proceedings disclosed.