Business Context and Reporting Period
West Pharmaceutical Services, Inc. manufactures packaging components and drug-delivery systems for injectable drugs and healthcare products, serving pharmaceutical, biologic, generic, diagnostic and medical-device customers. The filing is the Form 10-K for the fiscal year ended December 31, 2016; quarterly data for the fourth quarter is also provided. Beginning in 2016, the company reorganized its reportable segments into Proprietary Products and Contract-Manufactured Products, with prior periods retroactively adjusted.
- International sales represented 51.1% of consolidated sales.
- Approximately 7,300 employees were employed worldwide at year-end.
- The ten largest customers represented 36.8% of sales; no individual customer exceeded 10%.
Key Financial Metrics
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Net sales | $1,509.1 million | $1,399.8 million | 7.8% increase |
| Gross profit | $501.1 million | $455.8 million | 9.9% increase |
| Gross margin | 33.2% | 32.6% | 0.6 points higher |
| Operating profit | $196.8 million | $128.6 million | 53.0% increase |
| Operating margin | 13.0% | 9.2% | 3.8 points higher |
| Net income | $143.6 million | $95.6 million | 50.2% increase |
| Diluted EPS | $1.91 | $1.30 | 46.9% increase |
| Operating cash flow | $219.4 million | $212.4 million | $7.0 million increase |
- Proprietary Products sales increased 8.3% to $1,189.9 million, with a 37.7% gross margin.
- Contract-Manufactured Products sales increased 5.9% to $320.2 million, while gross margin declined to 16.6% from 17.0%.
- Adjusted operating profit, excluding unallocated items, was $223.8 million, or a 14.8% margin, compared with $189.9 million and 13.6% in 2015.
- Research and development spending increased 7.9% to $36.8 million.
- Net cash used in investing activities was $175.8 million, including $170.2 million of capital expenditures and an $8.4 million investment in an intradermal drug-delivery company.
- Net cash used in financing activities was $113.9 million, including $69.8 million of debt repayments, $52.2 million of share repurchases and $35.8 million of dividends paid.
Liquidity, Debt and Financial Position
- Cash and cash equivalents were $203.0 million at December 31, 2016, including $119.9 million held outside the United States.
- Working capital was $400.9 million, compared with $359.4 million at year-end 2015.
- Total debt was $228.6 million, down from $298.2 million, primarily because the $66.8 million Euro note B matured in February 2016.
- The company had $270.6 million of borrowing capacity under its $300.0 million multi-currency revolving credit facility, after outstanding borrowings and letters of credit.
- Net debt-to-total invested capital was 2.2%, compared with 2.3% in 2015. The company was in compliance with all debt covenants.
- Contractual obligations totaled $451.7 million, including debt, interest, operating leases, purchase obligations and acquisition-related contingencies.
Material Changes Versus the Prior Comparable Period
- Reported sales growth reflected strong growth in high-value proprietary products, partially offset by a $17.5 million unfavorable foreign-currency translation effect. Constant-currency sales growth was 9.1%.
- Gross margin improved through product-mix changes, production efficiencies and price increases, partly offset by higher labor and overhead costs.
- Operating profit benefited from substantially lower unusual charges than in 2015. The prior year included a $50.4 million pension settlement charge and $10.9 million of executive retirement and related costs.
- 2016 included $26.4 million of restructuring and related charges, including $8.9 million of severance and $17.3 million of non-cash asset write-downs.
- The company repurchased 700,000 shares for $52.2 million during 2016. A new authorization for up to 800,000 shares began January 1, 2017.
- Cash declined by $71.6 million, despite higher operating cash flow, because of elevated capital spending, debt repayments, dividends and share repurchases.
- Fourth-quarter 2016 sales were $382.3 million and net income was $39.1 million, compared with fourth-quarter 2015 sales of $359.7 million and net income of $33.4 million.
Guidance, Outlook, Risks and Unusual Items
Management did not provide a specific numerical 2017 earnings or sales forecast in the provided filing text. Management stated that cash on hand, operating cash flow and available credit were expected to meet foreseeable liquidity needs, and that the company intended to continue investing in new products, capacity expansion, quality systems and emerging markets.
- The FDA approved the first U.S. combination product incorporating the SmartDose technology in July 2016. Commercialization remains subject to customer adoption, regulatory approvals and development execution.
- Proprietary Products backlog declined to $373.3 million from $413.2 million, reflecting a return toward normal ordering patterns and foreign-currency effects. Most of the 2016 backlog was expected to be filled in 2017.
- The company expects commercial production at its new Waterford, Ireland facility to begin in 2018.
- Venezuela currency devaluation resulted in a $2.7 million charge. Further devaluations or changes in currency mechanisms could result in a pre-tax charge of up to $6.3 million.
- The U.S. qualified and non-qualified defined benefit pension plans are scheduled to be frozen as of January 1, 2019. The 2016 pension curtailment gain was $2.1 million.
- At year-end, pension plans were underfunded by $69.8 million and other postretirement benefits were underfunded by $8.0 million. Expected 2017 pension and other retirement contributions totaled $23.7 million.
- Key risks include foreign-currency volatility, reliance on injectable drug markets, pricing pressure, regulatory approval and product-development delays, manufacturing or supply-chain disruptions, dependence on single-source suppliers, raw-material and energy costs, customer consolidation, product liability, intellectual-property protection, cybersecurity and geopolitical conditions.
- SmartDose contingent consideration had a fair value of $8.0 million at year-end; the estimated probable amount payable over the next five years ranged from zero to $8.9 million.
- The company reported no material legal proceedings, no material environmental expenditures, no off-balance-sheet financing arrangements beyond ordinary-course leases, purchase obligations and letters of credit, and effective disclosure and internal financial controls.
Investor Verification Checklist
- Verify whether Proprietary Products growth, backlog conversion and SmartDose commercialization support the company’s stated growth strategy.
- Assess the sustainability of margin improvement after excluding restructuring charges, currency effects and other unallocated items.
- Review the pace of capital spending, the Waterford facility’s completion and the effect of investment spending on free cash flow.
- Monitor foreign-currency exposure, particularly the Euro, Singapore dollar, Danish krone, Yen and Venezuelan Bolivar.
- Evaluate pension funding requirements, the planned 2019 pension freeze and sensitivity to discount-rate and asset-return assumptions.
- Review debt maturities, revolving-credit availability and compliance with leverage and interest-coverage covenants.
- Consider supply concentration, raw-material pricing, customer concentration and regulatory requirements affecting pharmaceutical packaging and delivery devices.