Business Context and Reporting Period
West Pharmaceutical Services, Inc. designs and manufactures packaging components and delivery systems primarily for injectable drugs, with additional healthcare and consumer-product applications. Operations are organized into Packaging Systems and Delivery Systems. This Form 10-K covers the fiscal year ended December 31, 2013; fourth-quarter data are included in the unaudited quarterly schedule. Sales outside the United States represented 55% of consolidated sales.
Financial Performance and Position
| Metric | 2013 | 2012 | Change |
|---|---|---|---|
| Net sales | $1,368.4 million | $1,266.4 million | +8.0% |
| Gross profit | $434.7 million | $387.7 million | +12.1% |
| Gross margin | 31.8% | 30.6% | +1.2 points |
| Operating profit | $162.4 million | $135.1 million | +20.2% |
| Operating margin | 11.9% | 10.7% | +1.2 points |
| Net income | $112.3 million | $80.7 million | +39.1% |
| Diluted EPS | $1.57 | $1.15 | +$0.42 |
| Operating cash flow | $220.5 million | $187.4 million | +17.7% |
| Capital expenditures | $151.9 million | $131.3 million | +$20.6 million |
- Segment sales: Packaging Systems sales increased 8.8% to $996.0 million; Delivery Systems sales increased 6.2% to $374.1 million.
- Segment operating profit: Packaging Systems increased 15.7% to $217.0 million. Delivery Systems declined 48.9% to $9.4 million, primarily reflecting lower development income and higher costs.
- Fourth quarter: Net sales were $342.7 million, gross profit was $106.6 million, net income was $23.6 million, and diluted EPS was $0.33, compared with fourth-quarter 2012 net sales of $321.5 million and net income of $21.1 million.
- Liquidity: Cash and cash equivalents were $230.0 million, short-term investments were $7.5 million, and working capital was $413.8 million at year-end.
- Debt: Total debt was $373.5 million versus $411.5 million in 2012. Net debt-to-total invested capital improved to 13.7% from 25.5%. Available capacity under the principal revolving credit facility was $242.8 million.
- Cash deployment: Investing activities used $149.9 million, primarily for capital expenditures. Financing activities used $5.1 million, including $26.8 million of cash dividends.
- Research and development: R&D spending increased 14.2% to $37.9 million.
Material Changes Versus the Prior Comparable Period
- Revenue growth was driven by higher-value Packaging Systems products, stronger packaging-component volumes, price increases, and increased sales of CZ, administration, safety, and contract-manufacturing products.
- Foreign currency translation increased reported 2013 sales by $11.3 million and operating profit by $2.4 million. Excluding currency effects, sales increased 7.2%.
- Gross-margin improvement reflected price increases and product mix, partly offset by higher compensation, plant overhead, and raw-material costs.
- Net income benefited from the absence of the significant 2012 debt-extinguishment loss of $11.6 million and from the absence of 2012 restructuring and impairment charges. The 2013 debt-extinguishment loss was $0.2 million.
- The 2010 restructuring plan was completed in 2013; no related charges were recorded in 2013 and no future charges are expected.
- Delivery Systems recorded $2.0 million of development income in 2013, including $1.0 million recognized from a $20.0 million nonrefundable customer payment for SmartDose exclusivity. The remaining $19.0 million was deferred and will be recognized over the remaining 13-year agreement term. The agreement contains no future minimum purchase commitment.
- The quarterly dividend increased to $0.10 per share beginning in the fourth quarter of 2013. The company also completed a two-for-one stock split in September 2013.
Guidance, Outlook, Risks and Unusual Items
Management anticipates continued revenue and margin improvement, supported by demand for higher-quality Packaging Systems products, a greater mix of proprietary Delivery Systems products, capacity expansion, lean-cost initiatives, and emerging-market investment. The filing does not provide a specific numerical 2014 revenue or earnings forecast.
- Key risks include dependence on injectable drug products, customer pricing pressure and industry consolidation, regulatory approval and commercialization delays, product defects or recalls, manufacturing disruption, single-source raw materials, commodity-price inflation, foreign-exchange volatility, and international political or tax risks.
- SmartDose, CZ, FluroTec, and B2-coating technologies are important to the business and are licensed from Daikyo under agreements expiring in 2017, which management expects to renew.
- SmartDose contingent consideration was $4.3 million at year-end and is subject to changes in sales projections and commercialization outcomes. The filing estimates probable payments over the next five years could range from zero to $4.2 million.
- The company had a $76.1 million underfunded pension position and a $9.2 million underfunded other-retirement-benefit position. Expected 2014 pension contributions were $16.0 million, including a $13.1 million minimum ERISA contribution.
- Unrecognized tax benefits totaled $7.1 million, of which $6.9 million could favorably affect the effective tax rate if recognized. The company also accrued $3.0 million for Brazilian tax matters pending final court disposition.
- There were no reported legal proceedings, no unresolved SEC staff comments, and no material off-balance-sheet financing arrangements beyond operating leases, ordinary-course purchase obligations, and letters of credit.
- Management and the independent auditor concluded that disclosure controls and internal control over financial reporting were effective as of December 31, 2013.
Important Facts for Investors to Verify
- Whether Packaging Systems growth and margin gains can offset the much weaker Delivery Systems operating performance.
- The timing and commercial success of SmartDose, CZ, SelfDose, ConfiDose, and other proprietary product platforms.
- The renewal terms and continuing economics of Daikyo license, distributorship, and supply arrangements.
- The sustainability of cash flow after elevated capital expenditures and required pension contributions.
- Exposure to foreign currency, raw-material costs, variable interest rates, and refinancing requirements, including debt maturities beginning in 2015 and 2016.
- The potential cash and earnings effects of SmartDose contingent consideration, Brazilian tax matters, unrecognized tax benefits, and other contractual obligations.