West Pharmaceutical Services, Inc. — Q1 2018 Form 10-Q Summary
Business context and reporting period
West manufactures containment and delivery systems for injectable drugs and healthcare products, including proprietary packaging, drug-delivery products, analytical services, and contract-manufactured devices. Reportable segments are Proprietary Products and Contract-Manufactured Products. This unaudited Form 10-Q covers the three months ended March 31, 2018, compared with March 31, 2017.
Effective January 1, 2018, the company adopted ASC 606 using the modified retrospective method, recording an $11.4 million cumulative adjustment to retained earnings. The Venezuelan subsidiary was deconsolidated effective April 1, 2017, so year-over-year comparisons are affected.
Key financial metrics
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net sales | $415.7 million | $387.7 million | +7.2% |
| Gross profit | $134.4 million | $134.2 million | +0.1% |
| Gross margin | 32.3% | 34.6% | -2.3 percentage points |
| Operating profit | $53.4 million | $60.5 million | -11.7% |
| Operating margin | 12.8% | 15.6% | -2.8 percentage points |
| Net income | $43.6 million | $60.9 million | -28.4% |
| Diluted EPS | $0.58 | $0.81 | -28.4% |
| Cash flow from operations | $45.0 million | $20.7 million | +$24.3 million |
| Capital expenditures | $28.0 million | $37.5 million | -$9.5 million |
Foreign currency translation increased reported sales by $27.3 million and operating profit by $6.6 million. Excluding currency effects, sales increased only 0.2%.
Proprietary Products sales rose 5.7% as reported but declined 1.8% excluding currency. Contract-Manufactured Products sales rose 13.1% as reported and 7.9% excluding currency. Segment operating profit was $62.8 million for Proprietary Products, down from $65.1 million, and $9.5 million for Contract-Manufactured Products, up from $8.8 million.
Balance sheet, debt and liquidity
- Cash and cash equivalents were $199.8 million at March 31, 2018, down from $235.9 million at December 31, 2017.
- Working capital was $480.1 million, compared with $464.0 million at year-end.
- Total debt was $198.0 million, compared with $197.0 million at year-end; no current maturities were reported.
- Available borrowing capacity under the $300.0 million revolving credit facility was $266.6 million, after $30.6 million of borrowings and $2.8 million of letters of credit.
- Total equity was $1.305 billion. The company was in compliance with all debt covenants.
- Management stated that cash on hand, operating cash flow and credit availability should be adequate for foreseeable liquidity needs.
Material changes versus the prior comparable period
- Reported sales growth was largely attributable to favorable foreign exchange; constant-currency growth was minimal.
- Gross margin fell because of the Venezuelan deconsolidation, under-absorbed overhead at the Waterford, Ireland facility, the lost consumer-product contract-manufacturing customer, and lower profitability on certain development and tooling agreements.
- SG&A increased 9.3% to $68.3 million, including higher compensation, outside services and currency effects.
- Income tax expense increased to $12.5 million from $2.2 million. The effective tax rate rose to 23.3% from 3.6%, primarily because Q1 2017 included a $15.9 million tax benefit related to share-based payment accounting; Q1 2018 included a $0.3 million tax charge related to the 2017 Tax Act.
- Operating cash flow improved primarily because Q1 2017 included a $20.0 million contribution to the U.S. qualified pension plan.
- Financing cash use increased to $56.9 million, principally because share repurchases increased to $47.9 million from $26.9 million.
Guidance, outlook, commentary, risks and unusual items
- Management approved a restructuring plan to realign manufacturing capacity with demand. Implementation is expected over 12 to 24 months.
- Expected restructuring and related charges are $8.0 million to $13.0 million, with $9.0 million to $14.0 million of related capital expenditures. Expected annualized savings after completion are $17.0 million to $22.0 million.
- Q1 2018 included $3.3 million of restructuring charges, consisting of $2.0 million of severance, $0.1 million of asset write-downs and $1.2 million of other charges. Management reported a $2.7 million after-tax effect, or approximately $0.03 per diluted share.
- The Waterford facility is expected to begin commercial production in the second half of 2018, following validation procedures.
- The company authorized repurchases of up to 800,000 shares during 2018 and repurchased 540,000 shares for $47.9 million during the quarter, leaving 260,000 shares authorized at March 31.
- Key risks include customer demand and inventory changes, competition and pricing pressure, regulatory approval and commercialization of customer products, production efficiency and overhead absorption, reliance on suppliers and partners, skilled-labor availability, supply-chain disruptions, petroleum-based raw-material costs, foreign exchange volatility and healthcare legislation.
- Operating leases, purchase obligations and letters of credit were the principal off-balance-sheet arrangements identified. The filing reported no material changes to legal proceedings or previously disclosed risk factors.
Most important facts for investors to verify
- Whether constant-currency sales growth improves beyond the 0.2% reported for Q1 and whether the Venezuelan deconsolidation and lost customer create continuing revenue pressure.
- Progress at Waterford and the extent to which restructuring delivers the projected $17.0 million to $22.0 million of annual savings.
- Whether gross-margin compression reverses as production efficiencies improve and capacity is realigned.
- The final impact of ASC 606 on revenue timing, contract assets, deferred income and comparability with 2017 results.
- Whether cash generation remains sufficient to fund capital expenditures, restructuring costs, dividends and share repurchases without materially increasing debt.
- Foreign exchange, raw-material costs, customer concentration and the commercialization timing of customer products incorporating West systems.