Business Context and Reporting Period
West Pharmaceutical Services, Inc. filed an unaudited Form 10-Q for the quarter and nine months ended September 30, 2015. The company operates through Pharmaceutical Packaging Systems, which supplies packaging components for injectable drug delivery, and Delivery Systems, which provides drug-administration systems and contract manufacturing solutions.
Key Financial Metrics
| Metric | Q3 2015 | Q3 2014 | 9M 2015 | 9M 2014 |
|---|---|---|---|---|
| Net sales | $344.5 million | $355.9 million | $1,040.1 million | $1,071.6 million |
| Gross profit | $108.3 million | $109.9 million | $336.2 million | $338.1 million |
| Gross margin | 31.4% | 30.9% | 32.3% | 31.5% |
| Operating profit/(loss) | $(3.5) million | $44.0 million | $83.4 million | $137.4 million |
| Operating margin | (1.0)% | 12.4% | 8.0% | 12.8% |
| Net income | $1.5 million | $31.0 million | $62.2 million | $95.7 million |
| Diluted EPS | $0.02 | $0.43 | $0.85 | $1.32 |
| Operating cash flow | Not separately provided | Not separately provided | $144.4 million | $136.9 million |
Cash and cash equivalents were $256.8 million at September 30, 2015, compared with $255.3 million at December 31, 2014. Total debt was $302.5 million, down from $336.7 million, and net debt-to-total invested capital improved to 4.4% from 7.8%. Working capital was $381.0 million, compared with $406.8 million at year-end.
Nine-month investing cash outflows were $85.6 million, including $86.8 million of capital expenditures. Financing cash outflows were $39.9 million, including $23.7 million of dividend payments and $26.7 million of long-term debt repayments. Dividends declared increased to $0.12 per share in the quarter and $0.34 per share year to date.
Material Changes Versus the Prior Comparable Period
- Reported sales declined 3.2% in the quarter and 2.9% year to date, primarily because foreign currency translation reduced sales by approximately $30.0 million and $100.0 million, respectively. On a constant-currency basis, sales increased 5.2% in the quarter and 6.4% year to date.
- Packaging Systems performed well: constant-currency sales increased 8.5% in the quarter and 8.0% year to date, while operating profit increased 7.0% and 7.2%, respectively. Higher-value products represented 45.9% of segment sales in the quarter and 46.1% year to date.
- Delivery Systems weakened: constant-currency sales decreased 2.6% in the quarter but increased 2.3% year to date. Segment operating profit fell 72.9% in the quarter and 42.2% year to date, reflecting product mix, higher overhead and depreciation, lower SmartDose and drug-reconstitution administration-system sales, and the prior-year contract-services business sale.
- Gross margin improved by 0.5 percentage point in the quarter and 0.8 percentage point year to date, supported by Packaging Systems product mix, pricing and lower raw-material costs.
- Reported profitability was materially reduced by a $49.0 million pension settlement charge and $10.9 million of executive retirement and related costs. Excluding currency effects and these charges, management stated that nine-month sales increased 6.4% and diluted EPS increased 21.2% year over year.
Outlook, Commentary, Risks and Unusual Items
- The company did not provide specific formal revenue or EPS guidance in the filing. Management expects cash on hand, operating cash flow and revolving-credit availability to meet foreseeable liquidity needs.
- In the third quarter, West purchased a group annuity contract from MetLife using pension-plan assets. The transaction transferred $139.4 million of the $313.6 million U.S. qualified pension obligation covering approximately 1,750 retirees and generated the $49.0 million settlement charge. West also contributed $13.7 million to the plan in October 2015.
- Cash held outside the United States totaled $240.2 million at quarter-end; management intended to repatriate approximately $128.0 million during the fourth quarter without additional expected tax costs.
- On October 15, 2015, the company replaced its $300.0 million revolving facility with a new $300.0 million facility expiring in October 2020, expandable by up to $100.0 million subject to conditions and bank approval. Available capacity under the prior facility at quarter-end was $269.4 million.
- Management identified foreign-exchange volatility, especially the weaker Euro, as a significant headwind. The company also faces risks from customer demand and product approvals, competition, product mix, supply-chain interruptions, raw-material costs, reliance on suppliers and partners, regulatory matters, and the commercialization of SmartDose and other proprietary products.
- West continued using the official Venezuelan exchange rate. A change in the applicable rate or loss of access could result in a pre-tax charge of up to $6.6 million on Venezuelan monetary and non-monetary assets.
- Management stated that there were no significant changes to commitments and contingencies, no material changes to disclosed risk factors, no material legal proceedings, and no material changes to market-risk exposure. The CEO and CFO concluded that disclosure controls were effective.
Important Facts for Investors to Verify
- Separate recurring operating performance from the $49.0 million pension settlement charge and $10.9 million executive-retirement charge.
- Reconcile reported results with constant-currency growth and assess whether Packaging Systems momentum offsets Delivery Systems weakness.
- Monitor the effect of currency movements, particularly the Euro, on sales, earnings, accumulated other comprehensive income and debt balances.
- Review the new revolving-credit agreement, including leverage and interest-coverage covenants, maturity, pricing and available capacity.
- Assess pension funding after the MetLife transaction and the additional October 2015 contribution.
- Track SmartDose commercialization, contingent consideration revaluation and the $16.3 million of remaining deferred development income.
- Evaluate capital spending, cash repatriation plans, Venezuelan currency exposure and the company’s ability to sustain dividends while investing in new manufacturing capacity.