filings.toolsItem 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The following discussion is intended to further the reader's understanding of the consolidated financial condition and results of operations of our Company. It should be read in conjunction with our consolidated financial statements and the accompanying footnotes included in Part II, Item 8 of this Form 10-K. These historical financial statements may not be indicative of our future performance. This Management's Discussion and Analysis of Financial Condition and Results of Operations contains a number of forward-looking statements, all of which are based on our current expectations and could be affected by the uncertainties and risks discussed in Part I, Item 1A of this Form 10-K.
Non-U.S. GAAP Financial Measures
For the purpose of aiding the comparison of our year-over-year results, we may refer to net sales and other financial results excluding the effects of changes in foreign currency exchange rates. The constant-currency amounts are calculated by translating the current year’s functional currency results at the prior-year period’s exchange rate. We may also refer to consolidated operating profit and consolidated operating profit margin excluding the effects of unallocated items. The re-measured results excluding effects from currency translation and excluding the effects of unallocated items are not in conformity with U.S. GAAP and should not be used as a substitute for the comparable U.S. GAAP financial measures. The non-U.S. GAAP financial measures are incorporated into our discussion and analysis as management uses them in evaluating our results of operations, and believes that this information provides users a valuable insight into our results.
Our Operations
We are a leading global manufacturer in the design and production of technologically advanced, high-quality, integrated containment and delivery systems for injectable drugs and healthcare products. Our products include a variety of primary packaging, containment solutions, reconstitution and transfer systems, and drug delivery systems, as well as contract manufacturing and analytical lab services. Our customers include the leading biologic, generic, pharmaceutical, diagnostic, and medical device companies in the world. Our top priority is delivering quality products that meet the exact product specifications and quality standards customers require and expect. This focus on quality includes excellence in manufacturing, scientific and technical expertise and management, so we can partner with our customers to deliver safe, effective drug products to patients quickly and efficiently. The Company was incorporated under the laws of the Commonwealth of Pennsylvania on July 27, 1923.
Our business operations are organized into two reportable segments, Proprietary Products and Contract-Manufactured Products. Our Proprietary Products reportable segment offers proprietary packaging, containment and drug delivery products, along with analytical lab services, to biologic, generic and pharmaceutical drug customers. Our Contract-Manufactured Products reportable segment serves as a fully integrated business, focused on the design, manufacture, and automated assembly of complex devices, primarily for pharmaceutical, diagnostic, and medical device customers. We also maintain partnerships to share technologies and market products with affiliates in Japan and Mexico.
2017 Financial Performance Summary
Consolidated net sales increased by $90.0 million, or 6.0%, in 2017, including a favorable foreign currency translation impact of $12.2 million. Excluding foreign currency translation effects, consolidated net sales increased by $77.8 million, or 5.2%.
Consolidated operating profit increased by $32.1 million, or 16.3%, in 2017, including a favorable foreign currency translation impact of $1.6 million.
Net income in 2017 was $150.7 million, or $1.99 per diluted share, compared to $143.6 million, or $1.91 per diluted share, in 2016. Our 2017 results included the impact of a discrete tax charge of $48.8 million, or $0.64 per diluted share, related to the 2017 Tax Act and the impact of changes in enacted international tax rates on previously-recorded deferred tax asset and liability balances, a tax benefit of $33.1 million, or $0.44 per diluted share, associated with our adoption of the guidance issued by the FASB regarding share-based payment transactions, and a charge of $11.1 million, or $0.15 per diluted share, related to the deconsolidation of our Venezuelan subsidiary. Our 2016 results included the impact of restructuring and related charges of $17.4 million, or $0.23 per diluted share, a charge related to the devaluation of the Venezuelan Bolivar of $2.7 million, or $0.04 per diluted share, and a discrete tax charge of $1.0 million, or $0.01 per diluted share. Our 2016 results also included a pension curtailment gain of $1.3 million, or $0.01 per diluted share.
At December 31, 2017, our cash and cash equivalents balance totaled $235.9 million and our available borrowing capacity under our $300.0 million multi-currency revolving credit facility (the “Credit Facility”) was $267.5 million.
RESULTS OF OPERATIONS
We evaluate the performance of our segments based upon, among other things, segment net sales and operating profit. Segment operating profit excludes general corporate costs, which include executive and director compensation, stock-based compensation, adjustments to annual incentive plan expense for over- or under-attainment of targets, certain pension and other retirement benefit costs, and other corporate facilities and administrative expenses not allocated to the segments. Also excluded are items that we consider not representative of ongoing operations. Such items are referred to as other unallocated items and generally include restructuring and related charges, certain asset impairments and other specifically-identified income or expense items.
Percentages in the following tables and throughout this Results of Operations section may reflect rounding adjustments.
Net Sales
The following table presents net sales, consolidated and by reportable segment:
| Year Ended December 31, | % Change | ||||||||||||||||
| ($ in millions) | 2017 | 2016 | 2015 | 2017/2016 | 2016/2015 | ||||||||||||
| Proprietary Products | $ | 1,236.9 | $ | 1,189.9 | $ | 1,098.3 | 3.9 | % | 8.3 | % | |||||||
| Contract-Manufactured Products | 362.5 | 320.2 | 302.4 | 13.2 | % | 5.9 | % | ||||||||||
| Intersegment sales elimination | (0.3 | ) | (1.0 | ) | (0.9 | ) | — | — | |||||||||
| Consolidated net sales | $ | 1,599.1 | $ | 1,509.1 | $ | 1,399.8 | 6.0 | % | 7.8 | % |
2017 compared to 2016
Consolidated net sales increased by $90.0 million, or 6.0%, in 2017, including a favorable foreign currency translation impact of $12.2 million. Excluding foreign currency translation effects, consolidated net sales increased by $77.8 million, or 5.2%.
Proprietary Products – Proprietary Products net sales increased by $47.0 million, or 3.9%, in 2017, including a favorable foreign currency translation impact of $8.4 million. Excluding foreign currency translation effects, net sales increased by $38.6 million, or 3.2%. Proprietary Products sales growth in 2017 has been slower than in 2016, as customers continued to work down inventory purchased in 2016 mostly to address long production lead-times for high-value products. Additional production capacity and staffing improved our lead-times, and we began to see positive growth for customers in the Biologics and Generics market units. Higher sales volume contributed 2.2 percentage points of the increase, and sales price increases contributed 1.0 percentage points of the increase.
Contract-Manufactured Products – Contract-Manufactured Products net sales increased by $42.3 million, or 13.2%, in 2017, including a favorable foreign currency translation impact of $3.8 million. Excluding foreign currency translation effects, net sales increased by $38.5 million, or 12.0%, primarily due to the initial commercial ramp-up of projects that commenced in the latter half of 2016. Higher sales volume contributed 10.8 percentage points of the increase, and sales price increases contributed 1.2 percentage points of the increase.
2016 compared to 2015
Consolidated net sales increased by $109.3 million, or 7.8%, in 2016, including an unfavorable foreign currency translation impact of $17.5 million. Excluding foreign currency translation effects, consolidated net sales increased by $126.8 million, or 9.1%. Consolidated net sales originating in the U.S. in 2016 were $738.3 million, an increase of 10.6% from 2015. Consolidated net sales generated outside of the U.S. (mainly in Europe) in 2016 were $770.8 million, an increase of 5.2% from 2015. Excluding foreign currency translation effects, consolidated net sales generated outside of the U.S. in 2016 increased by 7.6%.
Proprietary Products – Proprietary Products net sales increased by $91.6 million, or 8.3%, in 2016, including an unfavorable foreign currency translation impact of $17.5 million. Excluding foreign currency translation effects, net sales increased by $109.1 million, or 9.9%, due to growth in our high-value product offerings, including products sold under our distributorship agreement with Daikyo and our Westar® and FluroTec-coated stoppers and plungers. An improvement in product mix and higher sales volumes contributed 9.1 percentage points of the increase, and sales price increases contributed the remainder of the increase.
Contract-Manufactured Products – Contract-Manufactured Products net sales increased by $17.8 million, or 5.9%, in 2016, primarily due to higher drug delivery and diagnostic product sales.
The intersegment sales elimination, which is required for the presentation of consolidated net sales, represents the elimination of components sold between our segments.
Gross Profit
The following table presents gross profit and related gross margins, consolidated and by reportable segment:
| Year Ended December 31, | % Change | ||||||||||||||||
| ($ in millions) | 2017 | 2016 | 2015 | 2017/2016 | 2016/2015 | ||||||||||||
| Proprietary Products: | |||||||||||||||||
| Gross profit | $ | 449.0 | $ | 448.0 | $ | 404.5 | 0.2 | % | 10.8 | % | |||||||
| Gross profit margin | 36.3 | % | 37.7 | % | 36.8 | % | |||||||||||
| Contract-Manufactured Products: | |||||||||||||||||
| Gross profit | $ | 63.6 | $ | 53.1 | $ | 51.3 | 19.8 | % | 3.5 | % | |||||||
| Gross profit margin | 17.5 | % | 16.6 | % | 17.0 | % | |||||||||||
| Consolidated gross profit | $ | 512.6 | $ | 501.1 | $ | 455.8 | 2.3 | % | 9.9 | % | |||||||
| Consolidated gross profit margin | 32.1 | % | 33.2 | % | 32.6 | % |
2017 compared to 2016
Consolidated gross profit increased by $11.5 million, or 2.3%, in 2017, including a favorable foreign currency translation impact of $3.3 million. Consolidated gross profit margin decreased by 1.1 margin points in 2017.
Proprietary Products – Proprietary Products gross profit increased by $1.0 million, or 0.2%, in 2017, including a favorable foreign currency translation impact of $2.6 million. Proprietary Products gross profit margin decreased by 1.4 margin points in 2017, as production efficiencies and modest price increases were more than offset by increased material labor and overhead costs.
Contract-Manufactured Products – Contract-Manufactured Products gross profit increased by $10.5 million, or 19.8%, in 2017, including a favorable foreign currency translation impact of $0.7 million. Contract-Manufactured Products gross profit margin increased by 0.9 margin points in 2017, as sales price increases, a favorable mix of products sold, higher sales volume, and production efficiencies were partially offset by increased labor, overhead, and depreciation costs.
2016 compared to 2015
Consolidated gross profit increased by $45.3 million, or 9.9%, in 2016, including an unfavorable foreign currency translation impact of $5.6 million. Consolidated gross profit margin increased by 0.6 margin points in 2016.
Proprietary Products – Proprietary Products gross profit increased by $43.5 million, or 10.8%, in 2016, including an unfavorable foreign currency translation impact of $5.6 million. Proprietary Products gross profit margin increased by 0.9 margin points in 2016, as product mix improvements, production efficiencies, and sales price increases were partially offset by increased labor and overhead costs.
Contract-Manufactured Products – Contract-Manufactured Products gross profit increased by $1.8 million, or 3.5%, in 2016. Contract-Manufactured Products gross profit margin decreased by 0.4 margin points in 2016, as increased labor and overhead costs were partially offset by a favorable mix of product sales and lower raw material costs.
Research and Development (“R&D”) Costs
The following table presents R&D costs, consolidated and by reportable segment:
| Year Ended December 31, | % Change | ||||||||||||||||
| ($ in millions) | 2017 | 2016 | 2015 | 2017/2016 | 2016/2015 | ||||||||||||
| Proprietary Products | $ | 39.1 | $ | 36.8 | $ | 34.1 | 6.3 | % | 7.9 | % | |||||||
| Contract-Manufactured Products | — | — | — | — | — | ||||||||||||
| Consolidated R&D costs | $ | 39.1 | $ | 36.8 | $ | 34.1 | 6.3 | % | 7.9 | % |
2017 compared to 2016
Consolidated R&D costs increased by $2.3 million, or 6.3%, in 2017, due to continued investment in self-injection systems development and formulation development.
2016 compared to 2015
Consolidated R&D costs increased by $2.7 million, or 7.9%, in 2016, due to continued investment in advanced delivery and container systems, process technology, and formulation development.
All of the R&D costs incurred during 2017 and 2016 related to Proprietary Products.
Selling, General and Administrative (“SG&A”) Costs
The following table presents SG&A costs, consolidated and by reportable segment and corporate:
| Year Ended December 31, | % Change | ||||||||||||||||
| ($ in millions) | 2017 | 2016 | 2015 | 2017/2016 | 2016/2015 | ||||||||||||
| Proprietary Products | $ | 176.6 | $ | 168.3 | $ | 159.4 | 4.9 | % | 5.6 | % | |||||||
| Contract-Manufactured Products | 15.4 | 15.2 | 15.8 | 1.3 | % | (3.8 | )% | ||||||||||
| Corporate | 50.6 | 56.3 | 57.8 | (10.1 | )% | (2.6 | )% | ||||||||||
| Consolidated SG&A costs | $ | 242.6 | $ | 239.8 | $ | 233.0 | 1.2 | % | 2.9 | % | |||||||
| SG&A as a % of net sales | 15.2 | % | 15.9 | % | 16.6 | % |
2017 compared to 2016
Consolidated SG&A costs increased by $2.8 million, or 1.2%, in 2017, including the impact of foreign currency translation, which increased SG&A costs by $1.2 million.
Proprietary Products – Proprietary Products SG&A costs increased by $8.3 million, or 4.9%, in 2017, due to increases in compensation costs, primarily related to headcount and merit increases. Foreign currency translation increased Proprietary Products SG&A costs by $1.2 million.
Contract-Manufactured Products – Contract-Manufactured Products SG&A costs increased by $0.2 million, or 1.3%, in 2017, due to an increase in incentive compensation and travel costs.
Corporate – Corporate’s SG&A costs decreased by $5.7 million, or 10.1%, in 2017, due to decreases in U.S. pension costs and stock-based compensation expense, partially offset by increases in headcount and outside services.
2016 compared to 2015
Consolidated SG&A costs increased by $6.8 million, or 2.9%, in 2016, including the impact of foreign currency translation, which decreased SG&A costs by $1.7 million.
Proprietary Products – Proprietary Products SG&A costs increased by $8.9 million, or 5.6%, in 2016, due to increases in compensation costs primarily related to merit increases and information system maintenance costs. Foreign currency translation decreased Proprietary Products SG&A costs by $1.7 million.
Contract-Manufactured Products – Contract-Manufactured Products SG&A costs decreased by $0.6 million, or 3.8%, in 2016, due to decreases in compensation and travel costs.
Corporate – Corporate’s SG&A costs decreased by $1.5 million, or 2.6%, in 2016, as a decrease in incentive compensation costs was partially offset by an increase in U.S. pension costs and stock-based compensation expense.
Other Expense
The following table presents other income and expense items, consolidated and by reportable segment and unallocated items:
| Expense (income) | Year Ended December 31, | ||||||||||
| ($ in millions) | 2017 | 2016 | 2015 | ||||||||
| Proprietary Products | $ | (8.9 | ) | $ | 1.0 | $ | (1.2 | ) | |||
| Contract-Manufactured Products | (0.1 | ) | (0.3 | ) | — | ||||||
| Corporate | (0.1 | ) | — | — | |||||||
| Unallocated items | 11.1 | 27.0 | 61.3 | ||||||||
| Consolidated other expense | $ | 2.0 | $ | 27.7 | $ | 60.1 |
Other income and expense items, consisting of foreign exchange transaction gains and losses, gains and losses on the sale of fixed assets, development and licensing income, contingent consideration, and miscellaneous income and charges, are generally recorded within segment results.
2017 compared to 2016
Consolidated other expense decreased by $25.7 million in 2017.
Proprietary Products – Proprietary Products other (income) expense changed by $9.9 million in 2017, primarily as we recorded income of $9.1 million attributable to the reimbursement of certain costs related to a technology that we subsequently licensed to a third party.
Contract-Manufactured Products – Contract-Manufactured Products other income decreased by $0.2 million in 2017, due to gains on the sale of fixed assets recorded in 2016, partially offset by foreign exchange transaction gains recorded in 2017.
Corporate – Corporate other income increased by $0.1 million in 2017.
Unallocated items – During 2017, as a result of the continued deterioration of conditions in Venezuela as well as our continued reduced access to USD settlement controlled by the Venezuelan government, we recorded a charge of $11.1 million related to the deconsolidation of our Venezuelan subsidiary, following our determination that we no longer met the U.S. GAAP criteria for control of that subsidiary. Please refer to Note 14, Other Expense, for further discussion of these items.
2016 compared to 2015
Consolidated other expense decreased by $32.4 million in 2016.
Proprietary Products – Proprietary Products other expense increased by $2.2 million in 2016, primarily due to increased contingent consideration and foreign exchange transaction losses.
Contract-Manufactured Products – Contract-Manufactured Products other income increased by $0.3 million in 2016, due to gains on the sale of fixed assets recorded in 2016.
Unallocated items – During 2016, we recorded $26.4 million in restructuring and related charges, consisting of $8.9 million for severance charges, $10.0 million for a non-cash asset write-down associated with the discontinued use of a trademark, $7.3 million for non-cash asset write-downs associated with the discontinued use of a patent and certain equipment, and $0.2 million for other charges. In addition, during 2016, we recorded a pension curtailment gain of $2.1 million in connection with our decision to freeze both our U.S. qualified and non-qualified defined benefit pension plans as of January 1, 2019, and recorded a charge of $2.7 million related to the devaluation of the Venezuelan Bolivar from the previously-prevailing official exchange rate of 6.3 Bolivars to USD to 10.0 Bolivars to USD. Please refer to Note 14, Other Expense, for further discussion of these items.
Operating Profit
The following table presents adjusted operating profit, consolidated and by reportable segment, corporate and unallocated items:
| Year Ended December 31, | % Change | ||||||||||||||||
| ($ in millions) | 2017 | 2016 | 2015 | 2017/2016 | 2016/2015 | ||||||||||||
| Proprietary Products | $ | 242.2 | $ | 241.9 | $ | 212.2 | 0.1 | % | 14.0 | % | |||||||
| Contract-Manufactured Products | 48.3 | 38.2 | 35.5 | 26.4 | % | 7.6 | % | ||||||||||
| Corporate | (50.5 | ) | (56.3 | ) | (57.8 | ) | (10.3 | )% | (2.6 | )% | |||||||
| Adjusted consolidated operating profit | $ | 240.0 | $ | 223.8 | $ | 189.9 | 7.2 | % | 17.9 | % | |||||||
| Adjusted consolidated operating profit margin | 15.0 | % | 14.8 | % | 13.6 | % | |||||||||||
| Unallocated items | (11.1 | ) | (27.0 | ) | (61.3 | ) | |||||||||||
| Consolidated operating profit | $ | 228.9 | $ | 196.8 | $ | 128.6 | 16.3 | % | 53.0 | % | |||||||
| Consolidated operating profit margin | 14.3 | % | 13.0 | % | 9.2 | % |
2017 compared to 2016
Consolidated operating profit increased by $32.1 million, or 16.3%, in 2017, including a favorable foreign currency translation impact of $1.6 million.
Proprietary Products – Proprietary Products operating profit increased by $0.3 million, or 0.1%, in 2017, including a favorable foreign currency translation impact of $0.9 million, due to the factors described above.
Contract-Manufactured Products – Contract-Manufactured Products operating profit increased by $10.1 million, or 26.4%, in 2017, including a favorable foreign currency translation impact of $0.7 million, due to the factors described above.
Corporate – Corporate costs decreased by $5.8 million, or 10.3%, in 2017, due to the factors described above.
Unallocated items – Please refer to the Other Expense section for details.
Excluding the unallocated items, our adjusted consolidated operating profit margin increased by 0.2 margin points in 2017.
2016 compared to 2015
Consolidated operating profit increased by $68.2 million, or 53.0%, in 2016, including an unfavorable foreign currency translation impact of $4.0 million.
Proprietary Products – Proprietary Products operating profit increased by $29.7 million, or 14.0%, in 2016, including an unfavorable foreign currency translation impact of $4.0 million, due to the factors described above.
Contract-Manufactured Products – Contract-Manufactured Products operating profit increased by $2.7 million, or 7.6%, in 2016, due to the factors described above.
Corporate – Corporate costs decreased by $1.5 million, or 2.6%, in 2016, due to the factors described above.
Unallocated items – Please refer to the Other Expense section for details.
Excluding the unallocated items, our adjusted consolidated operating profit margin increased by 1.2 margin points in 2016.
Interest Expense, Net
The following table presents interest expense, net, by significant component:
| Year Ended December 31, | % Change | ||||||||||||||||
| ($ in millions) | 2017 | 2016 | 2015 | 2017/2016 | 2016/2015 | ||||||||||||
| Interest expense | $ | 10.5 | $ | 11.7 | $ | 15.6 | (10.3 | )% | (25.0 | )% | |||||||
| Capitalized interest | (2.7 | ) | (3.6 | ) | (1.5 | ) | (25.0 | )% | 140.0 | % | |||||||
| Interest income | (1.3 | ) | (1.1 | ) | (1.6 | ) | 18.2 | % | (31.3 | )% | |||||||
| Interest expense, net | $ | 6.5 | $ | 7.0 | $ | 12.5 | (7.1 | )% | (44.0 | )% |
2017 compared to 2016
Interest expense, net, decreased by $0.5 million, or 7.1%, in 2017, due to lower interest expense resulting from less debt outstanding during 2017, partially offset by a decrease in capitalized interest.
2016 compared to 2015
Interest expense, net, decreased by $5.5 million, or 44.0%, in 2016, due to lower interest expense resulting from less debt outstanding during 2016 and increases in capitalized interest resulting from ongoing capital projects, including the construction of our new facility in Waterford, Ireland.
Income Taxes
The provision for income taxes was $80.9 million, $54.4 million, and $26.3 million for the years 2017, 2016, and 2015, respectively, and the effective tax rate was 36.4%, 28.7%, and 22.6%, respectively.
During 2017, we recorded a discrete tax charge of $48.8 million related to the 2017 Tax Act and the impact of changes in enacted international tax rates on previously-recorded deferred tax asset and liability balances, as well as a tax benefit of $33.1 million associated with our adoption of the guidance issued by the FASB regarding share-based payment transactions. Please refer to Note 15, Income Taxes, for further discussion of the 2017 Tax Act.
During 2016, we recorded a tax benefit of $9.0 million in connection with restructuring and related charges of $26.4 million, a discrete tax charge of $0.8 million related to the pension curtailment gain of $2.1 million, and a discrete tax charge of $1.0 million resulting from the impact of changes in enacted tax rates on our previously-recorded deferred tax asset and liability balances.
During 2015, we recorded a tax benefit of $18.4 million in connection with the pension settlement charge of $50.4 million, a tax benefit of $4.0 million in connection with the $10.9 million charge for executive retirement and related costs of $10.9 million, and a discrete tax charge of $0.8 million resulting from the impact of a change in the enacted tax rate in the United Kingdom on our previously-recorded deferred tax asset balances.
Please refer to Note 15, Income Taxes, for further discussion of our income taxes.
Equity in Net Income of Affiliated Companies
Equity in net income of affiliated companies represents the contribution to earnings from our 25% ownership interest in Daikyo and our 49% ownership interest in four companies in Mexico. Equity in net income of affiliated companies was $9.2 million, $8.2 million, and $5.8 million for the years 2017, 2016, and 2015, respectively. Equity in net income of affiliated companies increased by $1.0 million, or 12.2%, in 2017, due to the impact of gains on the sale of investment securities by Daikyo, partially offset by foreign exchange transaction losses in Mexico. Equity in net income of affiliated companies increased by $2.4 million, or 41.4%, in 2016, due to favorable operating results at Daikyo. Please refer to Note 5, Affiliated Companies, for further discussion of our affiliated companies.
Net Income
Net income in 2017 was $150.7 million, or $1.99 per diluted share, compared to $143.6 million, or $1.91 per diluted share, in 2016. Our 2017 results included the impact of a discrete tax charge of $48.8 million related to the 2017 Tax Act and the impact of changes in enacted international tax rates on previously-recorded deferred tax asset and liability balances, as well as a tax benefit of $33.1 million associated with our adoption of the guidance issued by the FASB regarding share-based payment transactions and a charge of $11.1 million related to the deconsolidation of our Venezuelan subsidiary.
Net income in 2016 was $143.6 million, or $1.91 per diluted share, compared to $95.6 million, or $1.30 per diluted share, in 2015. Our 2016 results included the impact of restructuring and related charges of $17.4 million (net of $9.0 million in tax), a charge related to the devaluation of the Venezuelan Bolivar of $2.7 million, a pension curtailment gain of $1.3 million (net of $0.8 million in tax), and a discrete tax charge of $1.0 million.
Net income in 2015 was $95.6 million, or $1.30 per diluted share, compared to $127.1 million, or $1.75 per diluted share, in 2014. Our 2015 results included the impact of a pension settlement charge of $32.0 million (net of $18.4 million in tax), a charge for executive retirement and related costs of $6.9 million (net of $4.0 million in tax) and a discrete tax charge of $0.8 million.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Cash Flows
The following table presents cash flow data for the years ended December 31:
| ($ in millions) | 2017 | 2016 | 2015 | ||||||||
| Net cash provided by operating activities | $ | 263.3 | $ | 219.4 | $ | 212.4 | |||||
| Net cash used in investing activities | $ | (133.6 | ) | $ | (175.8 | ) | $ | (129.5 | ) | ||
| Net cash used in financing activities | $ | (109.0 | ) | $ | (113.9 | ) | $ | (41.5 | ) |
Net Cash Provided by Operating Activities
2017 compared to 2016
Net cash provided by operating activities increased by $43.9 million in 2017, due to improved operating results.
2016 compared to 2015
Net cash provided by operating activities increased by $7.0 million in 2016, due to improved operating results and a decrease in pension plan contributions, partially offset by higher working capital requirements.
Net Cash Used in Investing Activities
2017 compared to 2016
Net cash used in investing activities decreased by $42.2 million in 2017, mostly due to a $39.4 million decrease in capital spending due to the completion of several major projects, including certain components of our new facility in Waterford, Ireland. The Waterford facility will continue to undergo validation procedures during 2018, with commercial production expected to begin in the second half of 2018.
2016 compared to 2015
Net cash used in investing activities increased by $46.3 million in 2016, due to an increase in capital spending, to $170.2 million, and our $8.4 million cost-method investment in an intradermal drug delivery company. The capital spending for 2016 consisted of spending for new products, expansion activity, and emerging markets, including the construction of our new facility in Waterford, Ireland.
Net Cash Used in Financing Activities
2017 compared to 2016
Net cash used in financing activities decreased by $4.9 million in 2017, due to a decrease in net debt repayments, partially offset by an increase in purchases under our share repurchase programs.
2016 compared to 2015
Net cash used in financing activities increased by $72.4 million in 2016, due to net debt repayments of $69.8 million, which included the maturity of our Euro note B, and $52.2 million in treasury share purchases under the repurchase program announced in December 2015, partially offset by increases in proceeds and excess tax benefits from employee stock plans.
We paid cash dividends totaling $39.1 million ($0.53 per share), $35.8 million ($0.49 per share), and $32.4 million ($0.45 per share) during 2017, 2016, and 2015, respectively.
Liquidity and Capital Resources
The table below presents selected liquidity and capital measures as of:
| ($ in millions) | December 31, 2017 | December 31, 2016 | |||||
| Cash and cash equivalents | $ | 235.9 | $ | 203.0 | |||
| Working capital | $ | 464.0 | $ | 400.9 | |||
| Total debt | $ | 197.0 | $ | 228.6 | |||
| Total equity | $ | 1,279.9 | $ | 1,117.5 | |||
| Net debt-to-total invested capital | N/A | 2.2 | % |
Cash and cash equivalents include all instruments that have maturities of ninety days or less when purchased. Working capital is defined as current assets less current liabilities. Net debt is defined as total debt less cash and cash equivalents, and total invested capital is defined as the sum of net debt and total equity. Net debt and total invested capital are non-U.S. GAAP financial measures that should not be used as a substitute for the comparable U.S. GAAP financial measures. The non-U.S. GAAP financial measures are incorporated into our discussion and analysis as management believes that this information provides users with a valuable insight into our overall performance and financial position.
Cash and cash equivalents – Our cash and cash equivalents balance at December 31, 2017 consisted of cash held in depository accounts with banks around the world and cash invested in high-quality, short-term investments. The cash and cash equivalents balance at December 31, 2017 included $100.5 million of cash held by subsidiaries within the U.S., and $135.4 million of cash held by subsidiaries outside of the U.S. During 2017, we repatriated $63.0
million of cash held by non-U.S. subsidiaries. We do not expect any additional tax costs associated with the repatriation. In response to the 2017 Tax Act, we reevaluated our position regarding permanent reinvestment of foreign subsidiary earnings and profits through 2017 (with the exception of China and Mexico, both of which will remain permanently reinvested) and elected to include in our provision for income taxes for the year ended December 31, 2017 an estimated liability of $9.8 million related to foreign withholding taxes and state income taxes that will be incurred upon the distribution of those foreign subsidiary earnings and profits to the U.S. at a future date. Please refer to Note 15, Income Taxes, for discussion of the undistributed earnings of our China and Mexico entities at December 31, 2017.
Working capital - Working capital at December 31, 2017 increased by $63.1 million, or 15.7%, as compared to December 31, 2016, including an increase of $24.7 million due to foreign currency translation. Excluding the impact of currency exchange rates, cash and cash equivalents, accounts receivable, inventories, and total current liabilities increased by $20.7 million, $39.7 million, $3.6 million, and $23.8 million, respectively. The increase in accounts receivable was due to increased sales activity and longer payment terms in 2017. The increase in current liabilities was due to an increase in accounts payable and other current liabilities, partially offset by the payment of our $33.1 million five-year term loan due January 2018.
Debt and credit facilities - The $31.6 million decrease in total debt at December 31, 2017, as compared to December 31, 2016, resulted from net debt repayments of $34.9 million, which included the payment of our $33.1 million five-year term loan due January 2018, partially offset by foreign currency rate fluctuations of $3.1 million and a reduction of $0.2 million in unamortized debt issuance costs.
Our sources of liquidity include our Credit Facility. At December 31, 2017, we had $29.6 million in outstanding long-term borrowings under this facility, of which $4.4 million was denominated in Yen and $25.2 million was denominated in Euro. These borrowings, together with outstanding letters of credit of $2.9 million, resulted in a borrowing capacity available under our Credit Facility of $267.5 million at December 31, 2017. We do not expect any significant limitations on our ability to access this source of funds. Please refer to Note 8, Debt, for further discussion of our Credit Facility.
Pursuant to the financial covenants in our debt agreements, we are required to maintain established interest coverage ratios and to not exceed established leverage ratios. In addition, the agreements contain other customary covenants, none of which we consider restrictive to our operations. At December 31, 2017, we were in compliance with all of our debt covenants, and we expect to continue to be in compliance with the terms of these agreements throughout 2018.
We believe that cash on hand and cash generated from operations, together with availability under our Credit Facility, will be adequate to address our foreseeable liquidity needs based on our current expectations of our business operations, capital expenditures and scheduled payments of debt obligations.
Commitments and Contractual Obligations
The following table summarizes our commitments and contractual obligations at December 31, 2017. These obligations are not expected to have a material impact on liquidity.
| Payments Due By Period | |||||||||||||||
| ($ in millions) | Total | Less than 1 year | 1 - 3 years | 3 - 5 years | More than 5 years | ||||||||||
| Purchase obligations (1) | $ | 75.6 | $ | 5.3 | $ | 18.3 | $ | 19.5 | $ | 32.5 | |||||
| Debt (including unamortized debt issuance costs) | 197.7 | — | 29.7 | 42.0 | 126.0 | ||||||||||
| Interest on debt and interest rate swaps (2) | 48.9 | 6.8 | 13.5 | 12.3 | 16.3 | ||||||||||
| Operating lease obligations | 79.1 | 13.2 | 19.9 | 12.9 | 33.1 | ||||||||||
| Other long-term liabilities (3) | 11.5 | 0.8 | 1.9 | 2.8 | 6.0 | ||||||||||
| Total contractual obligations (4) | $ | 412.8 | $ | 26.1 | $ | 83.3 | $ | 89.5 | $ | 213.9 |
| (1) | Our business creates a need to enter into various commitments with suppliers. In accordance with U.S. GAAP, these purchase obligations are not reflected in the accompanying consolidated balance sheets. These purchase commitments do not exceed our projected requirements and are in the normal course of business. |
| (2) | For fixed-rate long-term debt, interest was based on principal amounts and fixed coupon rates at year-end. Future interest payments on variable-rate debt were calculated using principal amounts and the applicable ending interest rate at year-end. Interest on fixed-rate derivative instruments was based on notional amounts and fixed interest rates contractually obligated at year-end. |
| (3) | Represents acquisition-related contingencies. In connection with certain business acquisitions, we agreed to make payments to the sellers if and when certain operating milestones are achieved, such as sales and operating income targets. |
| (4) | This table does not include obligations pertaining to pension and postretirement benefits because the actual amount and timing of future contributions may vary significantly depending upon plan asset performance, benefit payments, and other factors. Contributions to our plans are expected to be $2.5 million in 2018. See Note 13, Benefit Plans, for estimated benefit payments over the next ten years. |
Reserves for uncertain tax positions - The table above does not include $3.2 million of total gross unrecognized tax benefits as of December 31, 2017. Due to the high degree of uncertainty regarding the timing of potential cash flows, we cannot reasonably estimate the settlement periods for amounts which may be paid.
Letters of credit - We have letters of credit totaling $2.9 million supporting the reimbursement of workers' compensation and other claims paid on our behalf by insurance carriers. Our accrual for insurance obligations was $3.8 million at December 31, 2017, of which $0.9 million is in excess of our deductible and, therefore, is reimbursable by the insurance company.
OFF-BALANCE SHEET ARRANGEMENTS
At December 31, 2017, we had no off-balance sheet financing arrangements other than operating leases, unconditional purchase obligations incurred in the ordinary course of business, and outstanding letters of credit related to various insurance programs.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management's discussion and analysis addresses consolidated financial statements that are prepared in accordance with U.S. GAAP. The application of these principles requires management to make estimates and assumptions, some of which are subjective and complex, that affect the amounts reported in the consolidated financial statements. We believe the following accounting policies and estimates are critical to understanding and evaluating our results of operations and financial position:
Revenue Recognition: Revenue is recognized when persuasive evidence of a sales arrangement exists, title and risk of loss have transferred, the selling price is fixed or determinable, and collectability is reasonably assured. Generally, sales are recognized upon shipment or upon delivery to our customers' site, based upon shipping terms or legal requirements. Some customers receive pricing rebates upon attaining established sales volumes. We record rebate costs when sales occur based on our assessment of the likelihood that the required volumes will be attained. We also maintain an allowance for product returns, as we believe that we are able to reasonably estimate the amount of returns based on our substantial historical experience.
Impairment of Long-Lived Assets: Long-lived assets, including property, plant and equipment, are tested for impairment whenever circumstances indicate that the carrying value of these assets may not be recoverable. An asset is considered impaired if the carrying value of the asset exceeds the sum of the future expected undiscounted cash flows to be derived from the asset. Once an asset is considered impaired, an impairment loss is recorded within other
(income) expense for the difference between the asset's carrying value and its fair value. For assets held and used in the business, management determines fair value using estimated future cash flows to be derived from the asset, discounted to a net present value using an appropriate discount rate. For assets held for sale or for investment purposes, management determines fair value by estimating the proceeds to be received upon sale of the asset, less disposition costs. During 2016, as part of our restructuring plan, we recorded within other expense a $4.5 million non-cash asset write-down associated with the discontinued use of certain equipment.
Impairment of Goodwill and Other Intangible Assets: Goodwill and indefinite-lived intangible assets are tested for impairment at least annually, following the completion of our annual budget and long-range planning process, or whenever circumstances indicate that the carrying value of these assets may not be recoverable. Goodwill is tested for impairment at the reporting unit level, which is the same as, or one level below, our operating segments. In January 2017, the FASB issued guidance which removes the second step of the goodwill impairment test. A goodwill impairment charge will now be the amount by which a reporting unit's carrying amount exceeds its fair value, not to exceed the total amount of goodwill allocated to that reporting unit. This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2019. Early adoption is permitted. We adopted this guidance as of January 1, 2017, on a prospective basis. Considerable management judgment is necessary to estimate fair value. Amounts and assumptions used in our goodwill impairment test, such as future sales, future cash flows and long-term growth rates, are consistent with internal projections and operating plans. Amounts and assumptions used in our goodwill impairment test are also largely dependent on the continued sale of drug products delivered by injection and the packaging of drug products, as well as our timeliness and success in new-product innovation or the development and commercialization of proprietary multi-component systems. Changes in the estimate of fair value, including the estimate of future cash flows, could have a material impact on our future results of operations and financial position. Recent accounting guidance also allows entities to first assess qualitative factors, including macroeconomic conditions, industry and market considerations, cost factors, and overall financial performance, to determine whether it is necessary to perform the quantitative goodwill impairment test. As each of our reporting units had a fair value in excess of its carrying value of at least 180% within our 2016 annual impairment test, we elected to follow this guidance for our 2017 annual impairment test. Based upon our assessment, we determined that it was not more likely than not that the fair value of each of our reporting units was less than its carrying amount and determined that it was not necessary to perform the quantitative goodwill impairment test in 2017.
At December 31, 2015, a trademark had been determined to have an indefinite life and, therefore, was not subject to amortization. During 2016, as part of our restructuring plan, we recorded within other expense a $10.0 million non-cash asset write-down associated with the discontinued use of this trademark.
Intangible assets with finite lives are amortized using the straight-line method over their estimated useful lives, and reviewed for impairment whenever circumstances indicate that the carrying value of these assets may not be recoverable. During 2016, as part of our restructuring plan, we recorded within other expense a $2.8 million non-cash asset write-down associated with the discontinued use of a patent.
Employee Benefits: We maintain funded and unfunded defined benefit pension plans in the U.S. and a number of other countries that cover employees who meet eligibility requirements. In addition, we sponsor postretirement benefit plans which provide healthcare benefits for eligible employees who retire or become disabled. The measurement of annual cost and obligations under these defined benefit postretirement plans is subject to a number of assumptions, which are specific for each of our U.S. and foreign plans. The assumptions, which are reviewed at least annually, are relevant to both the plan assets (where applicable) and the obligation for benefits that will ultimately be provided to our employees. Two of the most critical assumptions in determining pension and retiree medical plan expense are the discount rate and expected long-term rate of return on plan assets. Other assumptions reflect demographic factors such as retirement age, rates of compensation increases, mortality and turnover and are evaluated periodically and updated to reflect our actual experience. For our funded plans, we consider the current and expected asset allocations of our plan assets, as well as historical and expected rates of return in estimating the long-term rate of return on plan assets. Under U.S. GAAP, differences between actual and expected results are generally accumulated in other comprehensive income (loss) as actuarial gains or losses and subsequently amortized into earnings over future periods.
Changes in key assumptions could have a material impact on our future results of operations and financial position. We estimate that every 25-basis point reduction in our long-term rate of return assumption would increase pension expense by $0.4 million, and every 25-basis point reduction in our discount rate would increase pension expense by $0.5 million. A decrease in the discount rate increases the present value of benefit obligations. Our net pension underfunded balance at December 31, 2017 was $48.5 million, compared to $69.8 million at December 31, 2016. Our underfunded balance for other postretirement benefits was $7.1 million at December 31, 2017, compared to $8.0 million at December 31, 2016.
Income Taxes: We estimate income taxes payable based upon current domestic and international tax legislation. In addition, deferred income tax assets and liabilities are established to recognize differences between the tax basis and financial statement carrying values of assets and liabilities. We maintain valuation allowances where it is more likely than not that all or a portion of a deferred tax asset will not be realized. The recoverability of tax assets is subject to our estimates of future profitability, generally at the respective subsidiary company and country level. Changes in tax legislation, business plans and other factors may affect the ultimate recoverability of tax assets or final tax payments, which could result in adjustments to tax expense in the period such change is determined.
When accounting for uncertainty in income taxes recognized in our financial statements, we apply a more-likely-than-not threshold for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.
Contingent Consideration
The fair value of the contingent consideration liability related to the SmartDose® technology platform (the “SmartDose contingent consideration”) was initially determined using a probability-weighted income approach, and is revalued at each reporting date or more frequently if circumstances dictate. Changes in the fair value of this obligation are recorded as income or expense within other (income) expense in our consolidated statements of income. The significant unobservable inputs used in the fair value measurement of the contingent consideration are the sales projections, the probability of success factors, and the discount rate. Significant increases or decreases in any of those inputs in isolation would result in a significantly lower or higher fair value measurement. As development and commercialization of the SmartDose technology platform progresses, we may need to update the sales projections, the probability of success factors, and the discount rate used. This could result in a material increase or decrease to the SmartDose contingent consideration.
See Note 1, Summary of Significant Accounting Policies and Note 2, New Accounting Standards, to our consolidated financial statements for additional information on our significant accounting policies, recently adopted accounting standards, and accounting standards issued but not yet adopted.
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