West Pharmaceutical Services, Inc. — 2015 First-Quarter Form 10-Q
Reporting period: Three months ended March 31, 2015. The unaudited results cover West Pharmaceutical Services and its subsidiaries. The company operates through Pharmaceutical Packaging Systems and Delivery Systems, serving pharmaceutical, healthcare, consumer-products, and drug-delivery markets.
Financial performance and position
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Net sales | $335.9 million | $346.8 million | Down 3.1%; up 6.5% excluding currency effects |
| Gross profit | $109.7 million | $106.4 million | Up 3.1% |
| Gross margin | 32.7% | 30.7% | Up 2.0 percentage points |
| Operating profit | $47.8 million | $39.3 million | Up 21.6% |
| Operating margin | 14.2% | 11.3% | Up 2.9 percentage points |
| Net income | $32.9 million | $27.1 million | Up 21.4% |
| Diluted EPS | $0.45 | $0.38 | Up $0.07 |
| Dividend declared per share | $0.11 | $0.10 | Up $0.01 |
- Packaging Systems sales were $242.5 million, down 4.1% reported but up 7.7% excluding currency. Segment operating profit increased to $60.9 million from $51.4 million.
- Delivery Systems sales were $93.5 million, down 0.5% reported but up 3.3% excluding currency. Segment operating loss was $0.5 million, compared with a $0.2 million loss in the prior year.
- Research and development expense declined to $7.5 million from $10.0 million. Selling, general and administrative expense declined to $55.2 million from $56.4 million.
- The effective tax rate increased to 28.4% from 27.6%, primarily because of changes in the geographic mix of earnings.
- Net cash used in operating activities was $1.9 million, compared with $8.8 million of cash provided in Q1 2014. The change primarily reflected a voluntary $20.0 million pension contribution.
- Capital expenditures were $30.4 million, compared with $31.7 million in the prior-year quarter. Net cash used in investing activities was $30.6 million.
- Net cash provided by financing activities was $1.2 million, compared with $26.2 million in Q1 2014. Cash and cash equivalents declined to $207.1 million from $255.3 million at December 31, 2014.
- Total debt was $330.7 million at March 31, 2015, including $98.8 million classified as current. Net debt-to-total invested capital increased to 11.6% from 7.8% at year-end.
- Available borrowing capacity under the revolving credit facility was $264.7 million, and the company was in compliance with its debt covenants.
Material changes versus the prior comparable period
- Reported sales were reduced by a $33.5 million unfavorable foreign-currency impact, primarily from the weaker euro. The average euro-to-dollar rate declined from $1.37 to $1.13.
- Underlying growth was driven primarily by Packaging Systems’ high-value products. Those products represented 46.6% of Packaging Systems sales, versus 42.0% in Q1 2014.
- Consolidated gross-margin expansion reflected improved product mix and production efficiencies in Packaging Systems. Delivery Systems margins declined because of higher-margin mix changes, increased overhead, and depreciation associated with new capabilities.
- Other income was $0.8 million, compared with other expense of $0.7 million, primarily because of foreign-exchange transaction gains versus losses in the prior year.
- Comprehensive income changed to a loss of $18.2 million from income of $25.7 million, primarily because of a $56.3 million after-tax foreign-currency translation loss.
- Working capital declined to $328.5 million from $406.8 million, partly because of currency translation and the reclassification of Euro Note B as current debt.
Outlook, commentary, risks, and unusual items
- Management anticipates long-term revenue and margin improvement from demand for higher-quality products, higher-margin Packaging Systems offerings, and increased proprietary-product sales in Delivery Systems.
- Management expects the translation of non-U.S.-dollar sales to adversely affect 2015 sales and earnings per share compared with 2014.
- The company appointed Eric M. Green as chief executive officer effective April 24, 2015. Donald E. Morel, Jr. planned to remain chairman through June 30, 2015 and retire July 1, 2015.
- West planned to expand manufacturing capacity with a new Waterford, Ireland facility. Groundbreaking was planned for June 2015, subject to final approval expected by mid-May.
- The company recognized $0.4 million of SmartDose development income in the quarter. Unearned income related to the $20.0 million customer payment was $17.1 million at March 31, 2015.
- The SmartDose contingent-consideration liability was $5.1 million. Its valuation depends on sales projections, probability-of-success assumptions, and the discount rate and could change materially.
- West reported $2.0 million of net monetary assets and $4.0 million of non-monetary assets denominated in Venezuelan bolivars. A future change in the applicable exchange mechanism or a significant devaluation could require a pre-tax charge of approximately $6.0 million.
- Key risks include foreign-exchange volatility, demand and product mix, regulatory approval and commercialization of customer products, competition, supply-chain disruption, dependence on critical suppliers and partners, raw-material costs, healthcare legislation, and the development and approval of proprietary products.
- There were no material changes to previously disclosed legal proceedings, risk factors, commitments, or contractual obligations. Management reported effective disclosure controls and no material changes to internal control over financial reporting.
Important facts for investors to verify
- Assess whether the reported underlying sales growth can continue after separating currency effects, particularly in Packaging Systems.
- Monitor euro and other currency movements, since currency translation materially reduced reported sales, comprehensive income, and equity.
- Evaluate Delivery Systems’ path from an operating loss to profitability and the commercial and regulatory progress of SmartDose and other proprietary products.
- Verify the timing, funding requirements, and expected returns of the Ireland manufacturing expansion and other capital projects.
- Review near-term debt maturities, including the $25.0 million Series B floating-rate notes due July 2015 and the $66.3 million Euro Note B due February 2016.
- Track operating cash conversion after the voluntary pension contribution, capital expenditures, dividends, and any future share repurchases.
- Reassess the potential Venezuelan currency charge and the sensitivity of SmartDose contingent consideration to updated forecasts.