West Pharmaceutical Services, Inc. — Q2 2019 Form 10-Q Summary
Business context and reporting period
West designs and manufactures containment, packaging, drug-delivery and contract-manufactured products for biologic, generic, pharmaceutical, diagnostic and medical-device customers. The filing covers the quarter and six months ended June 30, 2019; results are unaudited and should be read with the 2018 Form 10-K.
- Reportable segments: Proprietary Products and Contract-Manufactured Products.
- Shares outstanding at June 30, 2019: 73.7 million.
- In April 2019, West acquired its South Korean distributor for $18.9 million, including $11.2 million of customer-relationship intangibles and $2.6 million of goodwill.
Financial performance and key metrics
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|
| Net sales | $469.7 million | $447.5 million | $913.2 million | $863.2 million |
| Gross profit | $157.9 million | $142.2 million | $304.7 million | $276.6 million |
| Gross margin | 33.6% | 31.8% | 33.4% | 32.0% |
| Operating profit | $80.5 million | $60.3 million | $151.2 million | $113.7 million |
| Operating margin | 17.1% | 13.5% | 16.6% | 13.2% |
| Net income | $66.1 million | $56.1 million | $121.5 million | $99.7 million |
| Diluted EPS | $0.88 | $0.75 | $1.61 | $1.33 |
- Q2 sales increased 4.9%; six-month sales increased 5.8%. Excluding foreign-currency translation and $1.0 million of acquisition-related sales, organic sales growth was 8.1% for Q2 and 9.7% for the six months.
- Proprietary Products sales grew 4.1% reported and 7.5% organically in Q2. Contract-Manufactured Products sales grew 7.7% reported and 10.2% organically.
- Gross-margin expansion reflected favorable product mix, pricing and production efficiencies, partially offset by higher labor costs and the Vial2Bag recall.
- Q2 net margin was approximately 14.1%, compared with 12.5% in the prior-year quarter. Six-month net margin was approximately 13.3%, compared with 11.6%.
- Research and development expense was $9.6 million in Q2 and $19.4 million for the six months, down from $10.8 million and $20.4 million, respectively.
Cash flow, liquidity and capital structure
| Metric | Six months 2019 | Six months 2018 |
|---|
| Operating cash flow | $152.7 million | $127.0 million |
| Capital expenditures | $57.1 million | $48.2 million |
| Acquisitions | $18.9 million | — |
| Cash used in financing | $87.4 million | $82.6 million |
| Ending cash and equivalents | $326.7 million | $225.5 million |
- Cash declined from $337.4 million at December 31, 2018, primarily because of share repurchases, dividends and investment spending.
- Debt was $196.0 million at June 30, 2019, with no current debt. The new $300.0 million revolving facility expires in March 2024; $28.5 million was drawn and $269.0 million remained available, including the effect of letters of credit.
- Working capital was $631.1 million, up from $610.7 million at year-end. Accounts receivable and inventories increased to $330.8 million and $232.3 million, respectively.
- West stated that it was in compliance with all debt covenants and expects cash, operating cash flow and available credit to cover foreseeable liquidity needs.
- The company repurchased 800,000 shares for $83.1 million during the six months under its completed 2019 program and paid $22.2 million of dividends.
Material changes versus the prior comparable period
- Operating profit rose 33.5% in Q2 and 33.0% for the six months, despite unfavorable currency translation impacts of $3.8 million and $8.8 million, respectively.
- Adjusted operating profit margin, excluding unallocated items, increased to 17.4% in Q2 from 14.0% and to 16.8% for the six months from 13.8%.
- Foreign-exchange transaction gains materially increased other income: $4.8 million in Q2 and $8.6 million for the six months, versus $1.2 million and $0.8 million in the prior-year periods.
- The effective tax rate increased to 19.4% in Q2 from 9.9%, and to 21.1% for the six months from 16.2%. The 2018 periods included tax benefits related to the 2017 Tax Act.
- West adopted ASC 842 lease accounting on January 1, 2019, recording operating lease right-of-use assets of $74.5 million and lease liabilities of $76.6 million at June 30.
- U.S. qualified and non-qualified defined-benefit pension accruals ceased effective January 1, 2019, except for interest crediting.
Guidance, outlook, commentary, risks and unusual items
- The filing does not provide a specific annual revenue or earnings-per-share guidance range. Management expects restructuring activities to generate approximately $14.0 million of annualized savings once fully completed.
- The Vial2Bag product line was voluntarily recalled on January 24, 2019 because of reports of potentially unpredictable or variable dosing. West recorded Q2 and six-month provisions of $1.3 million and $5.8 million, respectively, and stated that it continues to work to return the products to market. A $11.3 million provision had been recorded in the fourth quarter of 2018.
- Restructuring charges were $1.4 million in Q2 and $2.0 million for the six months, compared with $2.2 million and $5.5 million in the prior-year periods. Remaining obligations under the 2018 plan were $2.3 million at June 30.
- Management identifies risks from customer demand and product commercialization, competition, product mix, production efficiency, raw-material and labor costs, third-party and single-source suppliers, supply-chain disruption, regulatory approvals, foreign-exchange movements and healthcare legislation.
- West uses foreign-currency and commodity derivatives to manage market exposures. Outstanding crude-oil options covered 105,891 barrels from July 2019 through September 2020 at a weighted-average strike price of $64.02 per barrel.
- There were no material changes to previously disclosed legal proceedings or risk factors. The company reported no legal proceedings in Part II, Item 1, and stated that existing contingencies are not expected to have a material adverse effect.
Important facts for investors to verify
- Whether Vial2Bag products return to the market and whether recall-related provisions are sufficient.
- The sustainability of organic growth and margin expansion after separating product mix, pricing, productivity, currency and one-time items.
- The extent to which foreign-exchange gains contributed to reported operating performance and whether they recur.
- Progress and remaining costs of the restructuring program, including realization of the expected $14.0 million annualized savings.
- Accounts-receivable and inventory growth, customer payment terms and working-capital conversion.
- Future capital expenditures, acquisitions, share repurchases and dividend requirements relative to operating cash flow.
- Compliance with the revolving-credit facility’s net-debt-to-modified-EBITDA covenant and available borrowing capacity.
- Potential effects of customer regulatory approvals, supply-chain concentration, raw-material prices and foreign-currency volatility.
