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. Organic net sales exclude the impact from acquisitions and/or divestitures and translate the current-period reported sales of subsidiaries whose functional currency is other than USD at the applicable foreign exchange rates in effect during the comparable prior-year period. We may also refer to adjusted consolidated operating profit and adjusted consolidated operating profit margin, which exclude the effects of unallocated items. The unallocated items are not representative of ongoing operations, and generally include restructuring and related charges, certain asset impairments, and other specifically-identified income or expense items. The re-measured results excluding effects from currency translation, the impact from acquisitions and/or divestitures, 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 in our discussion and analysis as management uses them in evaluating our results of operations and believes that this information provides users with a valuable insight into our overall performance and financial position.
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, analytical lab services and integrated solutions. Our customers include the leading biologic, generic, pharmaceutical, diagnostic, and additional 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 a commitment to excellence in manufacturing, scientific and technical expertise and management, which enables us to partner with our customers in order to deliver safe, effective drug products to patients quickly and efficiently.
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 and other integrated services and solutions, primarily 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 collaborations to share technologies and market products with affiliates in Japan and Mexico.
2020 Financial Performance Summary
The following tables present a reconciliation from U.S. GAAP to non-U.S. GAAP financial measures:
| ($ in millions) | Operating Profit | Income tax expense | Net income | Diluted EPS | |||||||||||||||||||
| Year ended December 31, 2020 GAAP | $ | 406.9 | $ | 72.5 | $ | 346.2 | $ | 4.57 | |||||||||||||||
| Unallocated items: | |||||||||||||||||||||||
| Restructuring and severance related charges | 7.0 | 1.7 | 5.3 | 0.07 | |||||||||||||||||||
| Pension settlement (1) | — | 0.9 | 2.9 | 0.04 | |||||||||||||||||||
| Amortization of acquisition-related intangible assets (2) | 0.6 | 0.1 | 3.6 | 0.05 | |||||||||||||||||||
| Cost investment impairment | 2.5 | — | 2.5 | 0.03 | |||||||||||||||||||
| Year ended December 31, 2020 adjusted amounts (non-U.S. GAAP) | $ | 417.0 | $ | 75.2 | $ | 360.5 | $ | 4.76 | |||||||||||||||
During 2020, we recorded a tax benefit of $20.8 million associated with stock-based compensation.
| ($ in millions) | Operating Profit | Income tax expense | Net income | Diluted EPS | |||||||||||||||||||
| Year ended December 31, 2019 GAAP | $ | 296.6 | $ | 59.0 | $ | 241.7 | $ | 3.21 | |||||||||||||||
| Unallocated items: | |||||||||||||||||||||||
| Restructuring and related charges | 4.9 | 1.2 | 3.7 | 0.04 | |||||||||||||||||||
| Gain on restructuring-related sale of assets | (1.7) | (0.4) | (1.3) | (0.02) | |||||||||||||||||||
| Pension settlement (1) | — | 0.8 | 2.7 | 0.04 | |||||||||||||||||||
| Argentina currency devaluation | 1.0 | — | 1.0 | 0.01 | |||||||||||||||||||
| Tax Recovery (3) | (4.4) | (1.5) | (2.9) | (0.04) | |||||||||||||||||||
| Tax law Changes (4) | — | 0.3 | (0.3) | — | |||||||||||||||||||
| Year ended December 31, 2019 adjusted amounts (non-U.S. GAAP) | $ | 296.4 | $ | 59.4 | $ | 244.6 | $ | 3.24 |
During 2019, we recorded a tax benefit of $10.3 million associated with stock-based compensation.
| ($ in millions) | Operating Profit | Income tax expense | Net income | Diluted EPS | |||||||||||||||||||
| Year ended December 31, 2018 GAAP | $ | 240.3 | $ | 41.4 | $ | 206.9 | $ | 2.74 | |||||||||||||||
| Restructuring and related charges | 9.1 | 1.9 | 7.2 | 0.09 | |||||||||||||||||||
| Gain on restructuring-related sale of assets | (1.1) | (0.2) | (0.9) | (0.01) | |||||||||||||||||||
| Argentina currency devaluation | 1.1 | — | 1.1 | 0.02 | |||||||||||||||||||
| Tax law Changes (4) | — | 2.5 | (2.5) | (0.03) | |||||||||||||||||||
| Year ended December 31, 2018 adjusted amounts (non-U.S. GAAP) | $ | 249.4 | $ | 45.6 | $ | 211.8 | $ | 2.81 |
During 2018, we recorded a tax benefit of $14.3 million associated with stock-based compensation.
(1) The Company recorded a pension settlement charge within other nonoperating (income) expense, as it determined that normal-course lump-sum payments for each of our U.S. qualified and non-qualified defined benefit pension plan exceeded the threshold for settlement accounting.
(2) The Company recorded $0.6 million of amortization expense within operating profit associated with an acquisition of an intangible asset during the second quarter of 2020. Additionally, the company recorded $3.1 million of amortization expense in association with an acquisition of increased ownership interest in Daikyo.
(3) The Company recorded a net tax recovery related to previously-paid international excise taxes, following a favorable court ruling.
(4) The Company recorded a net tax benefit in December 31, 2019 and December 31, 2018 of $0.3 million and $2.5 million, respectively, due to the impact of federal law changes enacted during the respective years.
RESULTS OF OPERATIONS
We evaluate the performance of our segments based upon, among other things, segment net sales and operating profit. Segment operating profit excludes general corporate costs, which include executive and director compensation, stock-based compensation, certain pension and other retirement benefit costs, and other corporate facilities and administrative expenses not allocated to the segments. Also excluded are items that we consider not representative of ongoing operations. Such items are referred to as other unallocated items for which further information can be found above in the reconciliation from U.S. GAAP to non-U.S. GAAP financial measures.
Percentages in the following tables and throughout this Results of Operations section may reflect rounding adjustments.
Net Sales
The following table presents net sales, consolidated and by reportable segment:
| Year Ended December 31, | % Change | ||||||||||||||||||||||||||||
| ($ in millions) | 2020 | 2019 | 2018 | 2020/2019 | 2019/2018 | ||||||||||||||||||||||||
| Proprietary Products | $ | 1,648.6 | $ | 1,398.6 | $ | 1,308.6 | 17.9 | % | 6.9 | % | |||||||||||||||||||
| Contract-Manufactured Products | 498.6 | 441.5 | 409.1 | 12.9 | % | 7.9 | % | ||||||||||||||||||||||
| Intersegment sales elimination | (0.3) | (0.2) | (0.3) | 50.0 | % | (33.3) | % | ||||||||||||||||||||||
| Consolidated net sales | $ | 2,146.9 | $ | 1,839.9 | $ | 1,717.4 | 16.7 | % | 7.1 | % |
2020 compared to 2019
Consolidated net sales increased by $307.0 million, or 16.7%, in 2020, including a favorable foreign currency translation impact of $5.7 million. Excluding foreign currency translation effects, as well as incremental sales of $1.2 million from the acquisition of our distributor in South Korea in 2019, consolidated net sales increased by $300.1 million, or 16.3%.
Proprietary Products – Proprietary Products net sales increased by $250.0 million, or 17.9%, in 2020, including a favorable foreign currency translation impact of $2.2 million. Excluding foreign currency translation effects, as well as $1.2 million of incremental sales in 2020 from the acquisition of our distributor in South Korea in 2019, net sales increased by $246.6 million, or 17.6%, primarily due to growth in our high-value product offerings, including our FluroTec-coated components, Westar® components, Daikyo® and NovaPure® components, Daikyo Crystal Zenith® products, and our self-injection delivery platforms, all of which included approximately $99 million in COVID-19 related activity for vaccines, antiviral treatments and treatment of underlying COVID-19 symptoms.
Contract-Manufactured Products – Contract-Manufactured Products net sales increased by $57.1 million, or 12.9%, in 2020, including a favorable foreign currency translation impact of $3.5 million. Excluding foreign currency translation effects, net sales increased by $53.5 million, or 12.1%, due to an increase in the sale of healthcare-related injection and diagnostic devices.
The intersegment sales elimination, which is required for the presentation of consolidated net sales, represents the elimination of components sold between our segments.
2019 compared to 2018
Consolidated net sales increased by $122.5 million, or 7.1%, in 2019, including an unfavorable foreign currency translation impact of $52.2 million. Excluding foreign currency translation effects, as well as incremental sales of $3.3 million from the acquisition of our distributor in South Korea in 2019, consolidated net sales increased by $171.4 million or 10.0%.
Proprietary Products – Proprietary Products net sales increased by $90.0 million, or 6.9%, in 2019, including an unfavorable foreign currency translation impact of $43.1 million. Excluding foreign currency translation effects, as well as incremental sales of $3.3 million from the acquisition of our distributor in South Korea in 2019, net sales increased by $129.8 million, or 9.9%, primarily due to growth in our high-value product offerings, including our Daikyo components, our ready-to-use seals, stoppers, and plungers, our NovaPure® components and Crystal Zenith products, and our self-injection systems and FluroTec-coated components.
Contract-Manufactured Products – Contract-Manufactured Products net sales increased by $32.4 million, or 7.9%, in 2019, including an unfavorable foreign currency translation impact of $9.1 million. Excluding foreign currency translation effects, net sales increased by $41.5 million, or 10.1%, due to an increase in the sale of healthcare-related injection and diagnostic devices.
The intersegment sales elimination, which is required for the presentation of consolidated net sales, represents the elimination of components sold between our segments.
Gross Profit
The following table presents gross profit and related gross margins, consolidated and by reportable segment:
| Year Ended December 31, | % Change | ||||||||||||||||||||||||||||
| ($ in millions) | 2020 | 2019 | 2018 | 2020/2019 | 2019/2018 | ||||||||||||||||||||||||
| Proprietary Products: | |||||||||||||||||||||||||||||
| Gross profit | $ | 682.2 | $ | 540.4 | $ | 485.4 | 26.2 | % | 11.3 | % | |||||||||||||||||||
| Gross profit margin | 41.4 | % | 38.6 | % | 37.1 | % | |||||||||||||||||||||||
| Contract-Manufactured Products: | |||||||||||||||||||||||||||||
| Gross profit | $ | 85.6 | $ | 65.5 | $ | 60.0 | 30.7 | % | 9.2 | % | |||||||||||||||||||
| Gross profit margin | 17.2 | % | 14.8 | % | 14.7 | % | |||||||||||||||||||||||
| Unallocated items | $ | — | $ | (0.2) | $ | — | |||||||||||||||||||||||
| Consolidated gross profit | $ | 767.8 | $ | 605.7 | $ | 545.4 | 26.8 | % | 11.1 | % | |||||||||||||||||||
| Consolidated gross profit margin | 35.8 | % | 32.9 | % | 31.8 | % |
2020 compared to 2019
Consolidated gross profit increased by $162.1 million, or 26.8%, in 2020, including a favorable foreign currency translation impact of $1.0 million. Consolidated gross profit margin increased by 2.9 margin points in 2020.
Proprietary Products – Proprietary Products gross profit increased by $141.8 million, or 26.2%, in 2020, including a favorable foreign currency translation impact of $0.3 million. Proprietary Products gross profit margin increased by 2.8 margin points in 2020, due to a favorable mix of products sold, production efficiencies, and sales price increases, partially offset by increased overhead costs including compensation costs and COVID-19 related expenses.
Contract-Manufactured Products – Contract-Manufactured Products gross profit increased by $20.1 million, or 30.7%, in 2020, including a favorable foreign currency translation impact of $0.7 million. Contract-Manufactured Products gross profit margin increased by 2.4 margin points in 2020, due to a favorable mix of products sold and production efficiencies, partially offset by increased overhead costs including compensation costs.
2019 compared to 2018
Consolidated gross profit increased by $60.3 million, or 11.1%, in 2019, including an unfavorable foreign currency translation impact of $15.7 million. Consolidated gross profit margin increased by 1.1 margin points in 2019.
Proprietary Products – Proprietary Products gross profit increased by $55.0 million, or 11.3%, in 2019, including an unfavorable foreign currency translation impact of $14.3 million. Proprietary Products gross profit margin increased by 1.5 margin points in 2019, due to a favorable mix of products sold, production efficiencies, and sales price increases, partially offset by increased overhead costs.
Contract-Manufactured Products – Contract-Manufactured Products gross profit increased by $5.5 million, or 9.2%, in 2019, including an unfavorable foreign currency translation impact of $1.4 million. Contract-Manufactured Products gross profit margin increased by 0.1 margin points in 2019, due to production efficiencies and lower material costs, partially offset by increased overhead costs and an unfavorable mix of products sold.
Research and Development (“R&D”) Costs
The following table presents consolidated R&D costs:
| Year Ended December 31, | % Change | ||||||||||||||||||||||||||||
| ($ in millions) | 2020 | 2019 | 2018 | 2020/2019 | 2019/2018 | ||||||||||||||||||||||||
| Consolidated R&D costs | $ | 46.9 | $ | 38.9 | $ | 40.3 | 20.6 | % | (3.5) | % |
2020 compared to 2019
Consolidated R&D costs increased by $8.0 million, or 20.6%, in 2020, as compared to 2019. Efforts remain focused on the continued investment in self-injection systems development, fluid transfer admixture devices, elastomeric packaging components, and formulation development.
2019 compared to 2018
Consolidated R&D costs decreased by $1.4 million, or 3.5%, in 2019, primarily due to an increase in customer-funded R&D projects via customer development agreements.
All of the R&D costs incurred during 2020, 2019 and 2018 related to Proprietary Products.
Selling, General and Administrative (“SG&A”) Costs
The following table presents SG&A costs, consolidated and by reportable segment and corporate and unallocated items:
| Year Ended December 31, | % Change | ||||||||||||||||||||||||||||
| ($ in millions) | 2020 | 2019 | 2018 | 2020/2019 | 2019/2018 | ||||||||||||||||||||||||
| Proprietary Products | $ | 197.5 | $ | 189.9 | $ | 185.0 | 4.0 | % | 2.6 | % | |||||||||||||||||||
| Contract-Manufactured Products | 15.5 | 16.2 | 16.5 | (4.3) | % | (1.8) | % | ||||||||||||||||||||||
| Corporate and unallocated items | 89.0 | 66.6 | 61.4 | 33.6 | % | 8.5 | % | ||||||||||||||||||||||
| Consolidated SG&A costs | $ | 302.0 | $ | 272.7 | $ | 262.9 | 10.7 | % | 3.7 | % | |||||||||||||||||||
| SG&A as a % of net sales | 14.1 | % | 14.8 | % | 15.3 | % |
2020 compared to 2019
Consolidated SG&A costs increased by $29.3 million, or 10.7%, in 2020 with no foreign currency translation impact.
Proprietary Products – Proprietary Products SG&A costs increased by $7.6 million, or 4.0%, in 2020, primarily due to an increase in compensation costs, partially offset by a reduction in travel expenses and incremental costs incurred in 2019 associated with our voluntary recall.
Contract-Manufactured Products – Contract-Manufactured Products SG&A costs decreased by $0.7 million, or 4.3%, in 2020, due to a reduction in travel expenses.
Corporate and unallocated items – Corporate SG&A costs increased by $22.4 million, or 33.6%, in 2020, primarily due to increases in stock-based compensation costs, incentive compensation costs and an increase in consulting service costs.
2019 compared to 2018
Consolidated SG&A costs increased by $9.8 million, or 3.7%, in 2019, including the impact of foreign currency translation, which decreased SG&A costs by $0.3 million.
Proprietary Products – Proprietary Products SG&A costs increased by $4.9 million, or 2.6%, in 2019, primarily due to an increase in compensation costs, incremental costs associated with our voluntary recall and the acquisition of our distributor in South Korea in 2019, partially offset by ongoing cost control measures. Foreign currency translation decreased Proprietary Products SG&A costs by $0.3 million.
Contract-Manufactured Products – Contract-Manufactured Products SG&A costs decreased by $0.3 million, or 1.8%, in 2019, due to ongoing cost control measures.
Corporate and unallocated items – Corporate SG&A costs increased by $5.2 million, or 8.5%, in 2019, primarily due to increases in stock-based compensation costs and incentive compensation costs, partially offset by a decrease in U.S. pension costs due to the cessation of our U.S. qualified and non-qualified defined benefit pension plans as of January 1, 2019 (except for interest crediting) and ongoing cost control measures.
Other Expense (Income)
The following table presents other expense and income items, consolidated and by reportable segment and corporate and unallocated items:
| Expense (Income) | Year Ended December 31, | ||||||||||||||||
| ($ in millions) | 2020 | 2019 | 2018 | ||||||||||||||
| Proprietary Products | $ | 3.3 | $ | (2.0) | $ | (6.3) | |||||||||||
| Contract-Manufactured Products | 1.5 | 0.2 | (0.8) | ||||||||||||||
| Corporate and unallocated items | 7.2 | (0.7) | 9.0 | ||||||||||||||
| Consolidated other expense (income) | $ | 12.0 | $ | (2.5) | $ | 1.9 |
Other expense and income 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.
2020 compared to 2019
Consolidated other expense (income) changed by $14.5 million in 2020.
Proprietary Products – Proprietary Products other expense (income) changed by $5.3 million in 2020, primarily due to an increase in the fixed asset impairments recorded, partially offset by a decrease in the SmartDose contingent consideration charge. Please refer to Note 12, Fair Value Measurements, for further discussion of this item.
Contract-Manufactured Products – Contract-Manufactured Products other expense (income) changed by $1.3 million in 2020 as compared to 2019, primarily due to an increase in foreign exchange transaction losses.
Corporate and unallocated items – Corporate and unallocated items changed by $7.9 million in 2020. During 2020, we recorded $4.6 million in restructuring and related charges and a $2.5 million impairment charge related to a cost investment. We expect that our 2020 restructuring plan will provide annualized savings in the range of $3.5 million to $4.5 million. In 2019, offsetting the $4.9 million restructuring and related charge and $1.0 million charge as a result of the continued devaluation of Argentina’s currency, the Company recorded a $1.9 million gain on the sale of fixed assets as a result of our 2018 restructuring plan and recognized a tax recovery of $4.7 million related to previously-paid international excise taxes, following a favorable court ruling.
2019 compared to 2018
Consolidated other expense (income) changed by $4.4 million in 2019.
Proprietary Products – Proprietary Products other expense (income) decreased by $4.3 million in 2019, primarily due to increased contingent consideration costs. Please refer to Note 12, Fair Value Measurements, for further discussion of this item.
Contract-Manufactured Products – Contract-Manufactured Products other expense (income) changed by $1.0 million in 2019, primarily due to a decrease in gains on the sale of fixed assets during 2019.
Corporate and unallocated items – Corporate and unallocated items changed by $9.7 million in 2019. During 2019, we recorded $4.9 million in restructuring and related charges, a $1.9 million gain on the sale of fixed assets as a result of our restructuring plan, and a charge of $1.0 million as a result of the continued devaluation of Argentina’s currency. In addition, during 2019, we recognized a tax recovery of $4.7 million related to previously-paid international excise taxes, following a favorable court ruling. Please refer to Note 16, Other Expense (Income), for further discussion of these items.
Operating Profit
The following table presents operating profit and adjusted operating profit, consolidated and by reportable segment, corporate and unallocated items:
| Year Ended December 31, | % Change | ||||||||||||||||||||||||||||
| ($ in millions) | 2020 | 2019 | 2018 | 2020/2019 | 2019/2018 | ||||||||||||||||||||||||
| Proprietary Products | $ | 434.5 | $ | 313.6 | $ | 266.4 | 38.6 | % | 17.7 | % | |||||||||||||||||||
| Contract-Manufactured Products | 68.6 | 49.1 | 44.3 | 39.7 | % | 10.8 | % | ||||||||||||||||||||||
| Corporate | (86.1) | (66.3) | (61.3) | 29.9 | % | 8.2 | % | ||||||||||||||||||||||
| Adjusted consolidated operating profit | $ | 417.0 | $ | 296.4 | $ | 249.4 | 40.7 | % | 18.8 | % | |||||||||||||||||||
| Adjusted consolidated operating profit margin | 19.4 | % | 16.1 | % | 14.5 | % | |||||||||||||||||||||||
| Unallocated items | (10.1) | 0.2 | (9.1) | ||||||||||||||||||||||||||
| Consolidated operating profit | $ | 406.9 | $ | 296.6 | $ | 240.3 | 37.2 | % | 23.4 | % | |||||||||||||||||||
| Consolidated operating profit margin | 19.0 | % | 16.1 | % | 14.0 | % |
2020 compared to 2019
Consolidated operating profit increased by $110.3 million, or 37.2%, in 2020, including a favorable foreign currency translation impact of $0.8 million.
Proprietary Products – Proprietary Products operating profit increased by $120.9 million, or 38.6%, in 2020, including a favorable foreign currency translation impact of $0.2 million, due to the factors described above, most notably the sales increase in our high-value product offerings, inclusive of COVID-19 related activity.
Contract-Manufactured Products – Contract-Manufactured Products operating profit increased by $19.5 million, or 39.7%, in 2020, including a favorable foreign currency translation impact of $0.6 million, due to the factors described above, most notably the sales increase in our products with a more favorable gross profit margin.
Corporate – Corporate costs increased by $19.8 million, or 29.9%, in 2020, which decreased operating profit, due to the factors described above most notably an increase in stock-based compensation costs and incentive compensation costs.
Unallocated items – Please refer to the 2020 Financial Performance Summary section above and Other Expense (Income) section for details.
Excluding the unallocated items, our adjusted consolidated operating profit margin increased by 3.3 margin points in 2020.
2019 compared to 2018
Consolidated operating profit increased by $56.3 million, or 23.4%, in 2019, including a favorable foreign currency translation impact of $0.6 million.
Proprietary Products – Proprietary Products operating profit increased by $47.2 million, or 17.7%, in 2019, including a favorable foreign currency translation impact of $0.6 million, due to the factors described above.
Contract-Manufactured Products – Contract-Manufactured Products operating profit increased by $4.8 million, or 10.8%, in 2019, due to the factors described above.
Corporate – Corporate costs increased by $5.0 million, or 8.2%, in 2019, which decreased operating profit, due to the factors described above.
Unallocated items – Please refer to the Other Expense (Income) section for details.
Excluding the unallocated items, our adjusted consolidated operating profit margin increased by 1.6 margin points in 2019.
Interest Expense, Net
The following table presents interest expense, net, by significant component:
| Year Ended December 31, | % Change | ||||||||||||||||||||||||||||
| ($ in millions) | 2020 | 2019 | 2018 | 2020/2019 | 2019/2018 | ||||||||||||||||||||||||
| Interest expense | $ | 9.6 | $ | 9.4 | $ | 9.3 | 2.1 | % | 1.1 | % | |||||||||||||||||||
| Capitalized interest | (1.4) | (0.9) | (0.9) | 55.6 | % | — | % | ||||||||||||||||||||||
| Interest income | (1.4) | (3.8) | (2.1) | (63.2) | % | 81.0 | % | ||||||||||||||||||||||
| Interest expense, net | $ | 6.8 | $ | 4.7 | $ | 6.3 | 44.7 | % | (25.4) | % |
2020 compared to 2019
Interest expense, net, increased by $2.1 million, or 44.7%, in 2020, due to a decrease in interest income in 2020 resulting from lower interest rates compared to the prior year, partially offset by an increase in capitalized interest due to an increase in capital expenditures in 2020.
2019 compared to 2018
Interest expense, net, decreased by $1.6 million, or 25.4%, in 2019, due to an increase in interest income in 2019 resulting from higher interest rates on our deposit accounts and higher average cash and cash equivalents balances.
Other Nonoperating (Income) Expense
2020 compared to 2019
Other nonoperating (income) expense changed by $1.3 million in 2020, primarily due to a decrease in the interest cost component of our net periodic benefit expense, partially offset by an increase in pension settlement charges. A pension settlement charge of $3.7 million was recorded in 2020, as we determined that normal-course lump-sum payments for each of our U.S. qualified and non-qualified defined benefit pension plans exceeded the threshold for settlement accounting under U.S. GAAP for the year.
2019 compared to 2018
Other nonoperating (income) expense changed by $6.8 million in 2019, primarily due to a decrease in the expected return on pension plan assets and a pension settlement charge of $3.5 million recorded in 2019, as we determined that normal-course lump-sum payments for each of our U.S. qualified and non-qualified defined benefit pension plans exceeded the threshold for settlement accounting under U.S. GAAP for the year. Effective January 1, 2019, except for interest crediting, benefit accruals under these defined benefit pension plans ceased.
Income Taxes
The provision for income taxes was $72.5 million, $59.0 million, and $41.4 million for the years 2020, 2019, and 2018, respectively, and the effective tax rate was 18.1%, 20.2%, and 17.2%, respectively.
During 2020, we recorded a tax benefit of $20.8 million associated with stock-based compensation, an increase from the tax benefit of $10.3 million associated with stock-based compensation in 2019, and incurred less tax on international operations versus the prior year, which both contributed to the effective tax rate decline from 20.2% in 2019 to 18.1% in 2020.
During 2019, we recorded a net tax benefit of $0.3 million due to the impact of federal law changes enacted during the year, as well as a tax benefit of $10.3 million associated with stock-based compensation.
During 2018, we recorded a net tax benefit of $2.5 million for the estimated impact of the 2017 Tax Act and a tax benefit of $14.3 million associated with stock-based compensation. Please refer to Note 17, Income Taxes, for further discussion of the 2017 Tax Act.
Please refer to Note 17, 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, which increased to 49% during the fourth quarter of 2019, and our 49% ownership interest in five companies majority-owned by a long-time partner located in Mexico. Please refer to Note 7, Affiliated Companies, for further discussion. Equity in net income of affiliated companies was $17.4 million, $8.9 million, and $7.6 million for the years 2020, 2019, and 2018, respectively. Equity in net income of affiliated companies increased by $8.5 million, or 95.5%, in 2020, primarily due to favorable operating results at Daikyo and the Mexico affiliates and increase in ownership of Daikyo starting in the fourth quarter of 2019. Equity in net income of affiliated companies increased by $1.3 million, or 17.1%, in 2019, primarily due to favorable operating results at Daikyo.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Cash Flows
The following table presents cash flow data for the years ended December 31:
| ($ in millions) | 2020 | 2019 | 2018 | ||||||||||||||
| Net cash provided by operating activities | $ | 472.5 | $ | 367.2 | $ | 288.6 | |||||||||||
| Net cash used in investing activities | $ | (179.5) | $ | (228.0) | $ | (100.8) | |||||||||||
| Net cash used in financing activities | $ | (137.1) | $ | (36.8) | $ | (80.7) |
Net Cash Provided by Operating Activities
2020 compared to 2019
Net cash provided by operating activities increased by $105.3 million in 2020, primarily due to improved operating results and changes in assets and liabilities.
2019 compared to 2018
Net cash provided by operating activities increased by $78.6 million in 2019, primarily due to improved operating results and changes in assets and liabilities.
Net Cash Used in Investing Activities
2020 compared to 2019
Net cash used in investing activities decreased by $48.5 million in 2020, primarily due to 2019 investing activities that did not recur in 2020, such as our increase in Daikyo ownership and the acquisition of our South Korea distributor in 2019. These reductions in investing activities were offset in 2020 by an increase in capital expenditures to support our increased customer demands.
2019 compared to 2018
Net cash used in investing activities increased by $127.2 million in 2019, primarily due to the increase in our ownership interest in Daikyo, an increase in capital expenditures, and the acquisition of our distributor in South Korea in 2019.
Net Cash Used in Financing Activities
2020 compared to 2019
Net cash used in financing activities increased by $100.3 million in 2020, primarily due an increase in purchases under our share repurchases program and given 2019 included new long-term borrowings while no such new borrowings occurred in 2020.
2019 compared to 2018
Net cash used in financing activities decreased by $43.9 million in 2019, primarily due to borrowings of $90.0 million under our Term Loan, partially offset by net repayments of our outstanding long-term borrowings under our Credit Facility and increases in purchases under our share repurchases programs and dividend payments.
Liquidity and Capital Resources
The table below presents selected liquidity and capital measures as of:
| ($ in millions) | December 31, 2020 | December 31, 2019 | |||||||||
| Cash and cash equivalents | $ | 615.5 | $ | 439.1 | |||||||
| Accounts receivable, net | $ | 385.3 | $ | 319.3 | |||||||
| Inventories | $ | 321.3 | $ | 235.7 | |||||||
| Accounts payable | $ | 213.1 | $ | 156.8 | |||||||
| Debt | $ | 255.2 | $ | 257.3 | |||||||
| Equity | $ | 1,854.5 | $ | 1,573.2 | |||||||
| Working Capital | $ | 870.3 | $ | 717.1 |
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.
Cash and cash equivalents – Our cash and cash equivalents balance at December 31, 2020 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, 2020 included $293.5 million of cash held by subsidiaries within the U.S. and $322.0 million of cash held by subsidiaries outside of the U.S. 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) and decided that those profits were no longer permanently reinvested. As of January 1, 2018, we reasserted indefinite reinvestment related to all post-2017 unremitted earnings in all of our foreign subsidiaries. In general, it is our practice and intention to permanently reinvest the earnings of our foreign subsidiaries and repatriate earnings only when the tax impact is de minimis, and that position has not changed subsequent to the one-time transition tax under the 2017 Tax Act, except as noted above. Accordingly, no deferred taxes have been provided for withholding taxes or other taxes that would result upon repatriation of approximately $345.6 million of undistributed earnings from foreign subsidiaries to the U.S., as those earnings continue to be permanently reinvested. Further, it is impracticable for us to estimate any future tax costs for any unrecognized deferred tax liabilities associated with our indefinite reinvestment assertion, because the actual tax liability, if any, would be dependent on complex analysis and calculations considering various tax laws, exchange rates, circumstances existing when there is a repatriation, sale or liquidation, or other factors.
Working capital - Working capital at December 31, 2020 increased by $153.2 million, or 21.4%, as compared to December 31, 2019, including an increase of $3.2 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 $156.0 million, $52.5 million, $73.7 million, and $119.1 million, respectively. The increase in accounts receivable was due to increased sales activity. The increase in inventories that occurred in the period was to ensure we have sufficient inventory on hand to support the needs of our customers. The increase in total current liabilities was primarily due to increases in accounts payable, accrued salaries, wages and benefits, accrued expenses, and income taxes payable.
Debt and credit facilities - The $2.1 million decrease in total debt at December 31, 2020, as compared to December 31, 2019, resulted from debt repayments under our Term Loan.
Our sources of liquidity include our Credit Facility. At December 31, 2020, we had no outstanding borrowings under the Credit Facility. At December 31, 2020, the borrowing capacity available under the Credit Facility, including outstanding letters of credit of $2.5 million, was $297.5 million. We do not expect any significant limitations on our ability to access this source of funds. Please refer to Note 10, Debt, for further discussion of our Credit Facility.
Pursuant to the financial covenants in our debt agreements, we are required to maintain established interest coverage ratios and to not exceed established leverage ratios. In addition, the agreements contain other customary covenants, none of which we consider restrictive to our operations. At December 31, 2020, we were in compliance with all of our debt covenants, and we expect to continue to be in compliance with the terms of these agreements throughout 2021.
We believe that cash on hand and cash generated from operations, together with availability under our Credit Facility, will be adequate to address our foreseeable liquidity needs based on our current expectations of our business operations, capital expenditures and scheduled payments of debt obligations.
Commitments and Contractual Obligations
The following table summarizes our commitments and contractual obligations at December 31, 2020. These obligations are not expected to have a material impact on liquidity.
| Payments Due By Period | |||||||||||||||||
| ($ in millions) | Total | Less than 1 year | 1 - 3 years (through 2023) | 3 - 5 years (through 2025) | More than 5 years | ||||||||||||
| Purchase obligations (1) | $ | 118.4 | $ | 41.4 | $ | 76.6 | $ | 0.4 | $ | — | |||||||
| Debt (excluding unamortized debt issuance costs) | 255.8 | 2.3 | 46.5 | 134.0 | 73.0 | ||||||||||||
| Interest on debt and cross-currency swap (2) | 30.3 | 7.0 | 11.6 | 7.3 | 4.4 | ||||||||||||
| Operating lease obligations | 85.2 | 12.4 | 19.7 | 15.6 | 37.5 | ||||||||||||
| Other long-term liabilities (3) | 7.4 | 0.7 | 1.2 | 2.4 | 3.1 | ||||||||||||
| Total contractual obligations (4) | $ | 497.1 | $ | 63.8 | $ | 155.6 | $ | 159.7 | $ | 118.0 |
(1)Our business creates a need to enter into various commitments with suppliers, including for the purchase of raw materials and finished goods. 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 floating-rate derivative instruments was based on notional amounts and floating 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. In 2021, we expect to contribute $3.6 million to pension plans, of which $2.9 million is for international plans. In addition, we expect to contribute $0.7 million for other retirement benefits in 2021. Please refer to Note 15, Benefit Plans, for estimated benefit payments over the next ten years.
Reserves for uncertain tax positions - The table above does not include $10.4 million of total gross unrecognized tax benefits as of December 31, 2020. 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 $2.5 million supporting the reimbursement of workers’ compensation and other claims paid on our behalf by insurance carriers. Our accrual for insurance obligations was $3.0 million at December 31, 2020, 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, 2020, we had no off-balance sheet financing arrangements other than 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: Our revenue results from the sale of goods or services and reflects the consideration to which we expect to be entitled in exchange for those goods or services. We record revenue based on a five-step model, in accordance with ASC Topic 606 (“ASC 606”). Following the identification of a contract with a customer, we identify the performance obligations (goods or services) in the contract, determine the transaction price, allocate the transaction price to the performance obligations in the contract, and recognize the revenue when (or as) we satisfy the performance obligations by transferring the promised goods or services to our customers. A good or service is transferred when (or as) the customer obtains control of that good or service.
We recognize the majority of our revenue, primarily relating to Proprietary Products product sales, at a point in time following the transfer of control of our products to our customers, which typically occurs upon shipment or delivery, depending on the terms of the related agreements.
We recognize revenue relating to our Contract-Manufactured Products product sales and certain Proprietary Products product sales over time, as our performance does not create an asset with an alternative use to us and we have an enforceable right to payment for performance completed to date.
We recognize revenue relating to our development and tooling agreements over time, as our performance creates or enhances an asset that the customer controls as the asset is created or enhanced.
For revenue recognized over time, revenue is recognized by applying a method of measuring progress toward complete satisfaction of the related performance obligation. When selecting the method for measuring progress, we select the method that best depicts the transfer of control of goods or services promised to our customers.
Revenue for our Contract-Manufactured Products product sales, certain Proprietary Products product sales, and our development and tooling agreements is recorded under an input method, which recognizes revenue on the basis of our efforts or inputs to the satisfaction of a performance obligation (for example, resources consumed, labor hours expended, costs incurred, time elapsed, or machine hours used) relative to the total expected inputs to the satisfaction of that performance obligation. The input method that we use is based on costs incurred.
The majority of the performance obligations within our contracts are satisfied within one year or less. Performance obligations satisfied beyond one year include those relating to a nonrefundable customer payment of $20.0 million received in June 2013 in return for the exclusive use of the SmartDose technology platform within a specific therapeutic area. As of December 31, 2020, there was $4.7 million of unearned income related to this payment, of which $0.9 million was included in other current liabilities and $3.8 million was included in other long-term liabilities. The unearned income is being recognized as income on a straight-line basis over the remaining term of the agreement. The agreement does not include a future minimum purchase commitment from the customer.
Our revenue can be generated from contracts with multiple performance obligations. When a sales agreement involves multiple performance obligations, each obligation is separately identified and the transaction price is allocated based on the amount of consideration we expect to be entitled in exchange for transferring the promised good or service to the customer.
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 and specific identification of customer claims.
Contract assets and liabilities result from transactions with revenue recorded primarily over time. If the measure of remaining rights exceeds the measure of the remaining performance obligations, we record a contract asset. Contract assets are recorded on the consolidated balance sheet in accounts receivable, net, and other assets (current and noncurrent portions, respectively). Contract assets included in accounts receivable, net, relate to the unbilled amounts of our product sales for which we have recognized revenue over time. Contract assets included in other assets represent the remaining performance obligations of our development and tooling agreements. Conversely, if the measure of the remaining performance obligations exceeds the measure of the remaining rights, we record a contract liability. Contract liabilities are recorded on the consolidated balance sheet in other liabilities (current and noncurrent portions, respectively) and represent cash payments received in advance of our performance.
Impairment of Long-Lived Assets: Long-lived assets, including property, plant and equipment and operating lease right-of-use assets, 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 expense (income) 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.
Impairment of Goodwill and Other Intangible Assets: Goodwill is 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. A goodwill impairment charge represents 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. 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. 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. We elected to follow this guidance for our 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.
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.
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. Postretirement benefit plans are limited to only those active employees who met the eligibility requirements as of January 1, 2017. The measurement of annual cost and obligations under these defined benefit pension and postretirement plans are 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 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. One of the most critical assumptions in determining retiree mental plan expense is the discount rate. 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 $0.6 million, and every 25-basis point reduction in our discount rate would decrease pension expense by $0.1 million. A decrease in the discount rate increases the present value of benefit obligations. Our net pension underfunded balance at December 31, 2020 was $40.8 million, compared to $43.8 million at December 31, 2019. Our underfunded balance for other postretirement benefits was $6.1 million at December 31, 2020, compared to $6.6 million at December 31, 2019.
Income Taxes: We estimate income taxes payable based upon current domestic and international tax legislation. In addition, deferred income taxes are recognized by applying enacted statutory tax rates to tax loss carryforwards and temporary differences between the tax basis and financial statement carrying values of our assets and liabilities. The enacted statutory tax rate applied is based on the rate expected to be applicable at the time of the forecasted utilization of the loss carryforward or reversal of the temporary difference. Valuation allowances on deferred tax assets are established when it is more likely than not that all or a portion of a deferred tax asset will not be realized. The realizability of deferred tax assets is subject to our estimates of future taxable income, 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.
Please refer to Note 1, Basis of Presentation and 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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