West Pharmaceutical Services, Inc. — Q2 2018 Form 10-Q Summary
Business context and reporting period
West is a global manufacturer of containment, packaging, drug-delivery and contract-manufactured products serving biologic, generic, pharmaceutical, diagnostic and medical-device customers. Reportable segments are Proprietary Products and Contract-Manufactured Products. This unaudited filing covers the three and six months ended June 30, 2018, compared with the corresponding 2017 periods.
The Company adopted ASC 606 revenue recognition on January 1, 2018 using the modified retrospective method. Prior-period results were not recast, limiting comparability. The adoption increased beginning retained earnings by $11.4 million.
Key financial metrics
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net sales | $447.5 million | $397.6 million | $863.2 million | $785.3 million |
| Gross profit | $142.2 million | $125.0 million | $276.6 million | $259.2 million |
| Gross margin | 31.8% | 31.4% | 32.0% | 33.0% |
| Operating profit | $60.3 million | $42.0 million | $113.7 million | $102.5 million |
| Operating margin | 13.5% | 10.6% | 13.2% | 13.1% |
| Net income | $56.1 million | $38.8 million | $99.7 million | $99.7 million |
| Diluted EPS | $0.75 | $0.51 | $1.33 | $1.32 |
Second-quarter sales increased 12.6% as reported and 9.0% excluding currency effects. Six-month sales increased 9.9% as reported and 4.7% excluding currency effects. Proprietary Products sales increased 10.6% in Q2 and 8.2% year to date; Contract-Manufactured Products sales increased 19.6% in Q2 and 16.5% year to date.
Adjusted operating profit, excluding unallocated items, was $62.5 million in Q2 and $119.2 million year to date, with margins of 14.0% and 13.8%, respectively. Contract-Manufactured Products profitability weakened despite higher sales: its gross margin declined to 13.1% in Q2 from 16.8% and to 13.9% year to date from 16.6%.
Net cash provided by operating activities was $127.0 million for the six months, compared with $106.0 million in 2017. Capital expenditures were $48.2 million versus $67.0 million, producing investing cash outflow of $45.7 million. Financing cash outflow was $82.6 million, including $70.8 million for share repurchases and $20.7 million of dividends. Cash decreased $10.4 million to $225.5 million.
At June 30, 2018, working capital was $479.3 million, total debt was $196.4 million, and total equity was $1.282 billion. The $300.0 million revolving credit facility had $268.3 million of available capacity after borrowings and letters of credit. The Company was in compliance with its debt covenants.
Material changes versus the prior comparable period
- Q2 net income increased 44.6%, primarily reflecting higher sales and operating profit, lower other expense, and favorable tax items. Six-month net income was flat because the prior-year period benefited from substantially larger share-based compensation tax benefits.
- Q2 operating margin improved 2.9 percentage points; six-month operating margin improved 0.1 percentage point. Q2 gross margin improved, but six-month gross margin declined one percentage point.
- Foreign currency translation contributed $14.0 million to Q2 sales growth and $41.3 million to six-month sales growth.
- Other expense declined to $1.1 million in Q2 and $4.2 million year to date, compared with $11.7 million and $12.6 million, respectively, in 2017. The 2017 amounts included an $11.1 million charge for deconsolidation of the Venezuelan subsidiary.
- Corporate SG&A increased 29.1% in Q2 and 22.5% year to date, primarily due to compensation costs and outside services.
- Accounts receivable rose to $296.7 million from $253.2 million at December 31, 2017, partly due to higher sales, longer customer payment terms and ASC 606.
- The Company repurchased 800,000 shares for $70.8 million during the first six months under its 2018 authorization.
Guidance, outlook, commentary and unusual items
No formal full-year revenue or earnings guidance is provided in the filing. Management expects its Waterford, Ireland facility to begin commercial production in the second half of 2018 after validation procedures.
A February 2018 restructuring plan will realign manufacturing capacity with demand over 12 to 24 months. Expected total restructuring charges are $8.0 million to $13.0 million, expected capital expenditures are $9.0 million to $14.0 million, and anticipated annualized savings after completion are $17.0 million to $22.0 million. Charges recorded through June 30 were $5.5 million.
Q2 and year-to-date results included tax benefits related to the 2017 Tax Act of $4.8 million and $4.5 million, respectively, as well as share-based compensation tax benefits of $3.4 million and $5.5 million. These items make reported earnings less indicative of underlying tax rates. The six-month effective tax rate was 16.2%, compared with 5.1% in 2017.
Key risks include customer demand and product commercialization, pricing and product mix, production efficiency and overhead absorption, raw-material and petroleum-based input costs, dependence on suppliers and partners, skilled-labor availability, foreign-exchange volatility, supply-chain disruptions, regulatory approvals, competition and healthcare legislation. The filing reports no material changes to previously disclosed risk factors and no material changes to commitments or contingencies. Legal proceedings are described as none.
Important facts for investors to verify
- Assess underlying sales and earnings growth excluding favorable currency translation, ASC 606 timing effects and discrete tax benefits.
- Monitor Contract-Manufactured Products margins, plant-consolidation costs, Waterford start-up costs and the impact of higher purchased-material content.
- Track execution of the restructuring plan, remaining charges, capital spending and whether projected annual savings of $17.0 million to $22.0 million are realized.
- Review accounts-receivable growth, customer payment terms and contract-asset and deferred-income balances following ASC 606 adoption.
- Evaluate liquidity after share repurchases, dividends, planned capital expenditures and the Company’s $196.4 million debt balance.
- Consider the sensitivity of results to currency movements, raw-material costs, customer product approvals, supplier concentration and demand for high-value proprietary products.