West Pharmaceutical Services, Inc. — Form 10-Q Summary
Reporting period: Quarter and six months ended June 30, 2014; filed August 1, 2014. The unaudited results cover Packaging Systems and Delivery Systems, which supply pharmaceutical packaging, drug-delivery components, proprietary delivery systems, and contract-manufacturing solutions.
Financial performance
| Metric | Three months ended June 30, 2014 | Three months ended June 30, 2013 | Six months ended June 30, 2014 | Six months ended June 30, 2013 |
|---|---|---|---|---|
| Net sales | $368.9 million | $344.5 million | $715.7 million | $683.9 million |
| Gross profit | $121.8 million | $110.9 million | $228.2 million | $222.6 million |
| Gross margin | 33.0% | 32.2% | 31.9% | 32.6% |
| Operating profit | $54.1 million | $42.5 million | $93.4 million | $85.9 million |
| Operating margin | 14.7% | 12.3% | 13.1% | 12.6% |
| Net income | $37.6 million | $30.2 million | $64.7 million | $61.9 million |
| Diluted EPS | $0.52 | $0.43 | $0.89 | $0.88 |
- Second-quarter sales increased 7.1%, including a $6.1 million favorable foreign-currency effect; constant-currency growth was 5.3%.
- Packaging Systems sales rose 6.6% in the quarter to $268.0 million, while Delivery Systems sales rose 8.3% to $101.1 million.
- Quarterly gross profit increased 9.8%, supported by favorable product mix, production efficiencies, price increases, and lower raw-material costs in Packaging Systems.
- SG&A declined 3.7% in the quarter and 4.0% year to date. Lower corporate pension, incentive compensation, stock-based compensation, and intellectual-property costs materially reduced corporate expenses.
- The effective tax rate increased to 27.7% in both 2014 periods, compared with 26.5% for the 2013 quarter and 24.2% for the 2013 six-month period, primarily because the 2013 R&D tax credit was unavailable in 2014 and geographic earnings mix changed.
Cash flow, liquidity, and capital structure
- Six-month operating cash flow was $73.0 million, down from $98.4 million. The comparison was affected by a $20.0 million SmartDose customer payment received in June 2013.
- Investing cash outflow was $57.0 million, including $56.2 million of capital expenditures, down from $83.8 million of capital expenditures in the prior-year period.
- Financing cash outflow was $19.0 million, compared with $15.3 million of financing inflow in the prior-year period. Dividends paid were $14.1 million.
- Cash and cash equivalents were $226.7 million at June 30, 2014, compared with $230.0 million at December 31, 2013. Short-term investments were $8.5 million.
- Working capital increased to $464.2 million from $413.8 million. Accounts receivable and inventory increased with higher sales activity and normal year-end seasonality.
- Total debt was $361.5 million, including $359.3 million of long-term debt, down from $373.5 million at year-end. Net debt-to-total invested capital improved to 12.2% from 13.7%.
- The revolving credit facility had $43.6 million outstanding, $3.5 million of letters of credit, and approximately $252.9 million of available borrowing capacity. The company was in compliance with its debt covenants.
- Approximately $203.6 million of cash was held outside the United States, primarily in Germany, Singapore, and Israel; repatriation may create U.S. tax obligations. The company repatriated approximately $27.8 million from Israel during June 2014.
Material changes and unusual items
- Quarterly performance improved substantially versus the prior year, while six-month gross margin declined 0.7 percentage points because of first-quarter product mix and relatively lower price increases.
- Packaging Systems six-month operating profit decreased 1.0% to $114.3 million despite sales growth, while Delivery Systems six-month operating profit remained $3.5 million.
- SmartDose and Daikyo Crystal Zenith product sales increased in the quarter. Proprietary products represented 27.1% of Delivery Systems sales in the quarter, compared with 25.6% a year earlier.
- Development income was $0.5 million in the quarter and $0.9 million year to date. Unearned income related to a prior $20.0 million SmartDose customer payment was $18.2 million at June 30, 2014.
- The SmartDose contingent consideration liability increased by $0.7 million year to date to $4.9 million, reflecting the time value of money and revised sales projections.
- Foreign-currency translation reduced other comprehensive income by $3.3 million year to date. The company uses interest-rate and foreign-exchange hedges and reported no material hedge ineffectiveness.
- The company reported no material changes to commitments, contingencies, risk factors, market-risk disclosures, or internal controls. Legal proceedings were reported as none.
Outlook, commentary, and risks
Management expects long-term revenue and margin improvement from demand for higher-quality packaging products, increased penetration of higher-margin proprietary Delivery Systems products, capacity expansion, restructuring and lean savings, and emerging-market growth. The company intends to continue investing in new products, capacity, expansion, and emerging markets.
Key risks include customer demand and inventory changes; competition and pricing pressure; regulatory approval and commercialization of products incorporating West systems; product mix; production and supply-chain interruptions; dependence on suppliers and partners including Daikyo; raw-material costs; availability of skilled labor; foreign-exchange movements; healthcare legislation; and the development and commercial success of SmartDose and Crystal Zenith products.
Management believes cash on hand, operating cash flow, and available revolver capacity will satisfy foreseeable liquidity needs. A potential Venezuela risk remains: the company held $2.2 million of net monetary assets denominated in Venezuelan bolivars, including $1.1 million of cash, and a future currency change or devaluation could require a pre-tax charge up to the amount of those assets.
Investor verification items
- Verify whether the second-quarter rebound in high-value Packaging Systems and proprietary Delivery Systems sales continued beyond June 30, particularly for SmartDose and Crystal Zenith.
- Track six-month gross-margin pressure and determine whether product mix, pricing, production efficiencies, and raw-material costs support management’s long-term margin outlook.
- Reconcile operating cash flow without the prior-year $20.0 million SmartDose payment and monitor working-capital growth, especially receivables and inventories.
- Review the maturity and interest-rate exposure of the $361.5 million debt balance, revolver utilization, and covenant compliance.
- Assess the valuation sensitivity of the $4.9 million SmartDose contingent consideration liability to sales projections, probability of success, and discount rates.
- Monitor foreign-exchange exposure, cash held offshore, Venezuela developments, and the potential tax cost of repatriation.