West Pharmaceutical Services, Inc. — Form 10-Q Summary
Business Context and Reporting Period
Quarterly report for the three and nine months ended September 30, 2016, filed October 31, 2016. West develops and manufactures pharmaceutical packaging, delivery systems, and complex contract-manufactured assemblies. Beginning in 2016, reportable segments were Proprietary Products and Contract-Manufactured Products; prior periods were retrospectively adjusted.
Key Financial Metrics
| Metric | Three Months 2016 | Three Months 2015 | Nine Months 2016 | Nine Months 2015 |
|---|---|---|---|---|
| Net sales | $376.7 million | $344.5 million | $1,126.8 million | $1,040.1 million |
| Gross profit | $121.1 million | $108.3 million | $377.7 million | $336.2 million |
| Gross margin | 32.1% | 31.4% | 33.5% | 32.3% |
| Operating profit (loss) | $51.3 million | $(3.5) million | $142.5 million | $83.4 million |
| Operating margin | 13.6% | (1.0)% | 12.6% | 8.0% |
| Net income | $37.6 million | $1.5 million | $104.5 million | $62.2 million |
| Diluted EPS | $0.50 | $0.02 | $1.40 | $0.85 |
Sales increased 9.4% in the quarter and 8.3% year to date. Excluding currency effects, sales increased 10.0% and 9.5%, respectively. Proprietary Products sales grew 10.7% in the quarter and 9.5% year to date, driven by high-value products, volume, product mix, and pricing. Contract-Manufactured Products sales grew 4.6% and 3.8%, respectively.
Adjusted consolidated operating profit, excluding unallocated items, was $53.6 million for the quarter and $168.9 million year to date, with adjusted margins of 14.2% and 15.0%, respectively. Research and development expense was $9.0 million for the quarter and $27.2 million year to date. SG&A was $58.3 million and $178.9 million, representing 15.5% and 15.9% of sales.
Cash Flow, Debt, and Liquidity
- Operating cash flow was $147.6 million for the first nine months, compared with $144.4 million in 2015.
- Capital expenditures were $122.7 million, compared with $86.8 million, reflecting new products, expansion, emerging-market investments, and construction of the Waterford, Ireland facility.
- Investing cash outflows were $129.1 million, including an $8.4 million cost-method investment in an intradermal drug-delivery company.
- Financing cash outflows were $87.5 million, including $69.2 million of debt repayments, $26.2 million of dividends, and $26.8 million of share repurchases.
- Cash and cash equivalents declined to $205.9 million from $274.6 million at December 31, 2015.
- Total debt was approximately $231.2 million, down from $298.2 million. Long-term debt, net of issuance costs, was $228.6 million.
- The company had $268.5 million of available borrowing capacity under its $300.0 million revolving credit facility, after outstanding borrowings and letters of credit. The company was in compliance with all debt covenants.
- Working capital increased to $421.3 million from $359.4 million. Management stated that cash, operating cash flow, and revolver availability should cover foreseeable liquidity needs.
Material Changes Versus the Prior Comparable Period
- Profitability improved substantially, primarily because the prior-year periods included a $49.0 million pension settlement charge and $10.9 million of executive retirement-related costs.
- 2016 included $23.7 million of restructuring charges year to date, consisting of severance and non-cash asset write-downs, compared with no restructuring charges in 2015.
- Year-to-date operating profit increased $59.1 million to $142.5 million; net income increased $42.3 million to $104.5 million.
- Gross margin expanded 70 basis points in the quarter and 120 basis points year to date, helped by product mix and pricing, partially offset by labor, overhead, and higher Yen-denominated material costs.
- Net interest expense declined 37.5% in the quarter and 40.4% year to date because of lower debt and increased capitalized interest.
- Cash investment increased because of higher capital spending, while debt reduction and repurchases increased financing outflows.
Guidance, Outlook, Risks, and Unusual Items
The filing does not provide explicit quantitative revenue or earnings guidance. Management cited continued growth in high-value proprietary products and expects the restructuring plan to generate additional charges during the remainder of 2016 and in 2017. Total restructuring charges are expected to be $25.0 million to $28.0 million; $23.7 million had been incurred through September 30, 2016.
- Management identified risks involving customer demand, competition, customer inventory changes, regulatory approval and commercialization of customer products, product mix, production efficiency, supply-chain interruptions, single-source suppliers, labor availability, raw-material costs, foreign exchange, and healthcare legislation.
- The company recorded a $2.7 million charge from the 2016 Venezuelan Bolivar devaluation. Further currency changes could result in an additional pre-tax charge of up to $6.0 million.
- SmartDose contingent consideration was $7.8 million at September 30, 2016. Its valuation depends on sales projections, probability of success, and discount rates and could change materially.
- Unearned income related to a $20.0 million SmartDose customer payment was $14.8 million and is being recognized over the remaining agreement term.
- Foreign exchange, interest-rate, and commodity-price exposures are managed with derivatives. The company also uses foreign-currency debt as net-investment hedges.
- The company reported no significant changes to previously disclosed legal contingencies or risk factors, no material off-balance-sheet financing arrangements beyond ordinary-course leases, purchase obligations, and letters of credit, and no legal proceedings requiring disclosure.
- Management concluded that disclosure controls were effective as of September 30, 2016, with no material changes to internal control over financial reporting.
Important Facts for Investors to Verify
- Whether growth in proprietary high-value products continues to offset currency pressure and rising labor, overhead, and material costs.
- The timing and final cost of the restructuring plan, including the remaining 2016 and 2017 charges.
- Capital-expenditure requirements and their effect on free cash flow, particularly the Waterford, Ireland facility.
- Progress on debt reduction, revolver utilization, and compliance with financial covenants.
- Potential additional Venezuela-related charges and sensitivity of SmartDose contingent consideration.
- Customer regulatory approvals, commercialization timing, product mix, and concentration or reliance on key suppliers and affiliates.