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WST > SEC Filings for WST > Form 10-Q on 5-Nov-2012All Recent SEC Filings

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Form 10-Q for WEST PHARMACEUTICAL SERVICES INC


5-Nov-2012

Quarterly Report


ITEM 2. 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 Management's Discussion and Analysis of Financial Condition and Results of Operations and the consolidated financial statements and accompanying notes included in our 2011 Annual Report. 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 our 2011 Annual Report and in Part II, Item 1A of this Quarterly Report on Form 10-Q.

Throughout this section, references to "Notes" refer to the footnotes to our condensed consolidated financial statements (unaudited) in Part I, Item 1 of this Quarterly Report on Form 10-Q, unless otherwise indicated.

Our Operations

Our business operations are organized into two reportable segments, which are aligned with the underlying markets and customers they serve. Our reportable segments are the Pharmaceutical Packaging Systems segment ("Packaging Systems") and the Pharmaceutical Delivery Systems segment ("Delivery Systems"). Packaging Systems develops, manufactures and sells primary packaging components and systems for injectable drug delivery, including stoppers and seals for vials, closures and other components used in syringe, intravenous and blood collection systems, and prefillable syringe components. Delivery Systems develops, manufactures and sells safety and administration systems, multi-component systems for drug administration, and a variety of custom contract-manufacturing solutions targeted to the healthcare and consumer-products industries. In addition, Delivery Systems is responsible for the continued development and commercialization of our line of proprietary, multi-component systems for injectable drug administration and other healthcare applications. We also maintain global partnerships to share technologies and market products with affiliates in Japan and Mexico.

Third Quarter 2012 Financial Performance Highlights

•         Net sales were $303.8 million, an increase of 3.5% from the same period
          in 2011.


•         Gross profit was $90.4 million, an increase of 11.1% from the same
          period in 2011, and our gross margin increased by 2.1 percentage
          points.


•         Operating profit was $26.3 million, an increase of 0.8% from the same
          period in 2011.


•         Net income was $14.8 million, a decrease of 12.4% from the same period
          in 2011.

We achieved higher net sales in both the Packaging Systems and Delivery Systems segments during the three months ended September 30, 2012, as compared to the same period in 2011. The overall sales growth was primarily the result of a favorable mix of products, modest unit volume growth, and sales price increases. Net sales originating in the United States were $145.9 million, an increase of 8.4% from the same period in 2011, reflecting higher domestic demand for pharmaceutical packaging components. Net sales generated outside of the United States were $157.9 million, a decrease of 0.7% from the same period in 2011, as demand in Europe and continued growth in the Asia-Pacific region was offset by an unfavorable foreign exchange impact. Excluding the unfavorable effects from currency translation, our non-U.S. net sales increased 9.9% and our consolidated net sales increased 9.2% from the same period in 2011.


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Gross profit increased by $9.0 million during the three months ended September 30, 2012, as compared to the same period in 2011, primarily due to sales price increases, a favorable mix of products, modest unit volume growth, and improved production efficiencies, all of which were partially offset by an unfavorable foreign exchange impact and the impact of increased raw material costs and wage, benefit and other cost increases.

Operating profit improved by $0.2 million during the three months ended September 30, 2012, as compared to the same period in 2011, primarily due to the increase in gross profit described above, partially offset by increases in R&D, primarily as a result of increased investment in next-generation packaging components, and SG&A costs, primarily due to increases in stock-based compensation expense and incentive compensation costs.

Net income decreased by $2.1 million, or $0.06 per diluted share, during the three months ended September 30, 2012, as compared to the same period in 2011, primarily due to the impact of discrete tax charges and an increase in our effective tax rate due to changes in our geographic mix of earnings.

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 management considers 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.

For the purpose of aiding the comparison of our year-over-year results, we often 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. These re-measured results excluding effects from currency translation are not in conformity with U.S. generally accepted accounting principles ("U.S. GAAP") and should not be used as a substitute for the related 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.

Percentages in the following tables and throughout the Results of Operations section may reflect rounding adjustments.

Net Sales

The following table presents net sales, consolidated and by reportable segment:

                          Three Months Ended         Nine Months Ended
                            September 30,              September 30,
($ in millions)            2012          2011        2012         2011
Packaging Systems      $    215.9      $ 209.1    $   687.4     $ 647.1
Delivery Systems             88.2         84.5        258.1       251.4
Intersegment sales           (0.3 )          -         (0.6 )      (1.6 )
Consolidated net sales $    303.8      $ 293.6    $   944.9     $ 896.9


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Consolidated net sales increased by $10.2 million, or 3.5%, for the three months ended September 30, 2012, as compared to the same period in 2011, despite an unfavorable foreign exchange impact of $16.8 million. Excluding foreign currency effects, net sales for the three months ended September 30, 2012 increased by $27.0 million, or 9.2%, as compared to the same period in 2011. A favorable mix of products and modest unit volume growth contributed 6.5 percentage points of the increase and sales price increases contributed 2.7 percentage points.

Consolidated net sales increased by $48.0 million, or 5.4%, for the nine months ended September 30, 2012, as compared to the same period in 2011, despite an unfavorable foreign exchange impact of $40.7 million. Excluding foreign currency effects, net sales for the nine months ended September 30, 2012 increased by $88.7 million, or 9.9%, as compared to the same period in 2011. A favorable mix of products and modest unit volume growth contributed 7.0 percentage points of the increase and sales price increases contributed 2.9 percentage points.

Packaging Systems - Packaging Systems' net sales increased by $6.8 million, or 3.3%, for the three months ended September 30, 2012, as compared to the same period in 2011, despite an unfavorable foreign exchange impact of $14.8 million. Excluding foreign exchange effects, net sales for the three months ended September 30, 2012 increased by $21.6 million, or 10.4%, as compared to the same period in 2011. A favorable mix of products and modest unit volume growth contributed 7.1 percentage points of the increase, and sales price increases contributed 3.3 percentage points. Our sales growth in the quarter continues to be led by our higher-quality product offerings that reduce particulate contamination and create efficiencies in our customer's manufacturing processes, including FluroTec™-coated closures, the Envision™ line of vision-inspected components, and Westar® ready-to-use components.

Packaging Systems' net sales increased by $40.3 million, or 6.2%, for the nine months ended September 30, 2012, as compared to the same period in 2011, despite an unfavorable foreign exchange impact of $35.5 million. Excluding foreign exchange effects, net sales for the nine months ended September 30, 2012 increased by $75.8 million, or 11.7%, as compared to the same period in 2011. A favorable mix of products and modest unit volume growth contributed 8.0 percentage points of the increase, and sales price increases contributed 3.7 percentage points. During the nine months ended September 30, 2012, in addition to increases in the sales of our standard pharmaceutical packaging components, there continued to be strong growth in sales of our high-value pharmaceutical packaging products, including the products described above.

Delivery Systems - Delivery Systems' net sales increased by $3.7 million, or 4.4%, for the three months ended September 30, 2012, as compared to the same period in 2011, despite an unfavorable foreign exchange impact of $2.0 million. Excluding foreign exchange effects, net sales for the three months ended September 30, 2012 increased by $5.7 million, or 6.7%, as compared to the same period in 2011. A favorable mix of products and modest unit volume growth contributed 5.7 percentage points of the increase, and sales price increases contributed 1.0 percentage points. Our sales increase during the three months ended September 30, 2012 was led by an increase in healthcare-related contract manufacturing revenue and higher sales of our proprietary administration systems and éris safety syringe product lines, as compared to the same period in 2011, partially offset by a decline in consumer product sales.

Delivery Systems' net sales increased by $6.7 million, or 2.7%, for the nine months ended September 30, 2012, as compared to the same period in 2011, despite an unfavorable foreign exchange impact of $5.2 million. Excluding foreign exchange effects, net sales for the nine months ended September 30, 2012 increased by $11.9 million, or 4.8%, as compared to the same period in 2011. A favorable mix of products and modest unit volume growth contributed 3.9 percentage points of the increase, and sales price increases contributed 0.9 percentage points. Our sales increase during the nine months ended September 30, 2012 was led by an increase in healthcare-related contract manufacturing revenue and higher sales of our proprietary administration systems and éris safety syringe product lines, as compared to the same period in 2011, partially offset by a decline in consumer 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.


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Gross Profit

The following table presents gross profit and related gross margins,
consolidated and by reportable segment:

                             Three Months Ended         Nine Months Ended
                               September 30,              September 30,
($ in millions)               2012          2011        2012         2011
Packaging Systems:
Gross Profit              $    71.9       $ 66.0     $   239.8     $ 208.4
Gross Margin                   33.3 %       31.6 %        34.9 %      32.2 %
Delivery Systems:
Gross Profit              $    18.5       $ 15.4     $    50.4     $  45.6
Gross Margin                   21.0 %       18.2 %        19.5 %      18.2 %
Consolidated Gross Profit $    90.4       $ 81.4     $   290.2     $ 254.0
Consolidated Gross Margin      29.8 %       27.7 %        30.7 %      28.3 %

Consolidated gross profit increased by $9.0 million, or 11.1%, for the three months ended September 30, 2012, as compared to the same period in 2011, despite an unfavorable foreign exchange impact of $4.2 million. Consolidated gross margin increased by 2.1 percentage points for the three months ended September 30, 2012, as compared to the same period in 2011, primarily as a result of sales price increases, a favorable mix of products sold and unit volume growth, all of which increased the consolidated gross margin by 2.7 percentage points. Improved production efficiencies also increased our consolidated gross margin by 1.3 percentage points. These favorable items were partially offset by the impact of increased raw material costs, which reduced our consolidated gross margin by 0.6 percentage points, and wage, benefit and other cost increases, which reduced our consolidated gross margin by 1.3 percentage points.

Consolidated gross profit increased by $36.2 million, or 14.3%, for the nine months ended September 30, 2012, as compared to the same period in 2011, despite an unfavorable foreign exchange impact of $11.0 million. Consolidated gross margin increased by 2.4 percentage points for the nine months ended September 30, 2012, as compared to the same period in 2011, primarily as a result of sales price increases, a favorable mix of products sold and unit volume growth, all of which increased the consolidated gross margin by 3.6 percentage points. Improved production efficiencies also increased our consolidated gross margin by 0.7 percentage points. These favorable items were partially offset by the impact of increased raw material costs, which reduced our consolidated gross margin by 0.9 percentage points, and wage, benefit and other cost increases, which reduced our consolidated gross margin by 1.0 percentage points.

Packaging Systems - Packaging Systems' gross profit increased by $5.9 million, or 8.9%, for the three months ended September 30, 2012, as compared to the same period in 2011, despite an unfavorable foreign exchange impact of $4.0 million. Packaging Systems' gross margin increased by 1.7 percentage points for the three months ended September 30, 2012, as compared to the same period in 2011, primarily as a result of sales price increases, a favorable mix of products sold and unit volume growth, all of which increased Packaging Systems' gross margin by 3.5 percentage points. Improved production efficiencies also increased Packaging Systems' gross margin by 0.6 percentage points. These favorable items were partially offset by the impact of increased raw material costs and increased wages, benefits and other costs, which reduced Packaging Systems' gross margin by 2.4 percentage points in total.


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Packaging Systems' gross profit increased by $31.4 million, or 15.1%, for the nine months ended September 30, 2012, as compared to the same period in 2011, despite an unfavorable foreign exchange impact of $10.6 million. Packaging Systems' gross margin increased by 2.7 percentage points for the nine months ended September 30, 2012, as compared to the same period in 2011, primarily as a result of sales price increases, a favorable mix of products sold and unit volume growth, all of which increased Packaging Systems' gross margin by 4.5 percentage points. Improved production efficiencies also increased Packaging Systems' gross margin by 0.3 percentage points. These favorable items were partially offset by the impact of increased raw material costs and increased wages, benefits and other costs, which reduced Packaging Systems' gross margin by 1.4 percentage points and 0.7 percentage points, respectively.

Delivery Systems - Delivery Systems' gross profit increased by $3.1 million, or 20.1%, for the three months ended September 30, 2012, as compared to the same period in 2011, despite an unfavorable foreign exchange impact of $0.2 million. Delivery Systems' gross margin increased by 2.8 percentage points for the three months ended September 30, 2012, as compared to the same period in 2011. Production efficiencies, restructuring cost savings and increased contract manufacturing activity contributed 2.5 percentage points of the increase, with the remaining increase due mostly to favorable raw material prices, which offset wage, benefit and utility cost increases.

Delivery Systems' gross profit increased by $4.8 million, or 10.5%, for the nine months ended September 30, 2012, as compared to the same period in 2011, despite an unfavorable foreign exchange impact of $0.4 million. Delivery Systems' gross margin increased by 1.3 percentage points for the nine months ended September 30, 2012, as compared to the same period in 2011. Production efficiencies, restructuring cost savings and increased contract manufacturing activity contributed 1.5 percentage points of the increase, partially offset by the net impact of wage, benefit and other cost increases in excess of our sales price increases.

Research and Development ("R&D") Costs

                     Three Months Ended             Nine Months Ended
                       September 30,                  September 30,
($ in millions)        2012            2011          2012           2011
R&D costs       $     8.2             $ 7.7    $     24.6          $ 21.9

R&D costs increased by $0.5 million, or 6.5%, for the three months ended September 30, 2012, as compared to the same period in 2011, primarily as a result of increased investment in next-generation packaging components. R&D costs increased by $2.7 million, or 12.3%, for the nine months ended September 30, 2012, as compared to the same period in 2011, primarily as a result of development work on the SmartDose electronic patch injector system and increased investment in next-generation packaging components.

Selling, General and Administrative ("SG&A") Costs

                            Three Months Ended         Nine Months Ended
                              September 30,              September 30,
($ in millions)              2012          2011        2012         2011
SG&A costs               $    53.7       $ 45.7     $   159.5     $ 142.7
SG&A as a % of net sales      17.7 %       15.5 %        16.9 %      15.9 %


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SG&A costs increased by $8.0 million, or 17.5%, for the three months ended September 30, 2012, as compared to the same period in 2011, primarily due to increases in stock-based compensation expense and incentive compensation costs, both of which were partially offset by foreign currency translation effects, which decreased SG&A costs by $1.8 million. The increase in stock-based compensation expense was primarily due to the impact of higher share prices on our deferred compensation plan liabilities, which are indexed to our share price, and the increase in incentive compensation costs resulted from our current achievement expectations related to our incentive plans.

SG&A costs increased by $16.8 million, or 11.8%, for the nine months ended September 30, 2012, as compared to the same period in 2011, primarily due to increases in stock-based compensation expense, incentive compensation costs, and the U.S. pension expense, all of which were partially offset by foreign currency translation effects, which decreased SG&A costs by $4.0 million. The increases in stock-based compensation expense and incentive compensation costs were due to the same factors that drove the increases for the three months ended September 30, 2012.

Restructuring and Other Items

The following table presents restructuring charges and other income and expense
items for our segments, and corporate and other unallocated items:

                                        Three Months Ended                  Nine Months Ended
                                           September 30,                      September 30,
($ in millions) Expense (income)      2012               2011             2012              2011
Segments                         $        0.7       $        0.6     $       (3.5 )     $       0.9
Corporate and other unallocated
items:
Corporate                                (0.1 )                -             (0.1 )            (0.1 )
Restructuring and related
charges                                   1.1                1.0              1.8               4.3
Impairment charge                           -                  -              3.4                 -
Special separation benefits                 -                  -                -               2.1
Acquisition-related
contingencies                             0.5                0.3              0.9              (0.4 )
Consolidated restructuring and
other items                      $        2.2       $        1.9     $        2.5       $       6.8

Other income and expense items, consisting primarily of gains and losses on the sale of fixed assets, foreign exchange transaction gains and losses, and miscellaneous income, are generally recorded within segment or corporate results. Certain restructuring, impairments and other specifically-identified gains and losses considered outside of the control of segment management are not allocated to our segments.

During the three and nine months ended September 30, 2012, segment results also included development income attributable to services provided to, and the reimbursement of certain costs from, a Delivery Systems' customer.

Restructuring and related charges - During the three and nine months ended September 30, 2012, we incurred restructuring and related charges of $1.1 million and $1.8 million, respectively, associated with the 2010 plan. Charges incurred during the three and nine months ended September 30, 2012 included facility closure costs and employee severance and benefits associated with a reduction in operations at a manufacturing facility in England, as well as facility closure costs associated with the 2011 closure of a plant in the United States. During the three months ended September 30, 2012, we finalized an agreement concerning future manufacturing and supply requirements at our manufacturing facility in England, which triggered an impairment review of the related assets. Our review concluded that the estimated fair value of these assets no longer exceeded their carrying value and therefore, an impairment charge of $1.5 million was recorded. We estimated the fair value of the assets using an income approach based on discounted cash flows. Offsetting the costs incurred during the three and nine months ended September 30, 2012 were reductions to certain obligations under the 2010 plan, including a reduction of $1.7


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million following the cancellation of the restructuring initiative at one of our plants in Europe as a result of increased customer demand for products and related efficiency improvements at that plant. During the three and nine months ended September 30, 2011, we incurred restructuring and related charges of $1.0 million and $4.3 million, respectively, which were associated with the 2010 plan and which were primarily for employee severance and benefits, as well as asset transfer and facility closure costs. We currently expect to incur additional charges related to the 2010 plan of approximately $0.2 million during the fourth quarter of 2012, after which no additional charges are expected to occur.

Impairment charge - During the second quarter of 2012, as a result of continuing delays and lower-than-expected demand, we updated the sales projections related to one of our Delivery Systems' product lines. The revised projections triggered an impairment review of the associated assets. Our review concluded that the estimated fair value of the product line no longer exceeded the carrying value of the related assembly equipment and intangible asset and, therefore, an impairment charge of $3.4 million was recorded. We estimated the fair value of the asset group using an income approach based on discounted cash flows.

Special separation benefits - During the nine months ended September 30, 2011, we incurred $2.1 million in special separation benefits related to the retirement of our former President and Chief Operating Officer. These costs consisted primarily of stock-based compensation expense. The respective equity compensation arrangements were amended to allow certain of his awards to continue to vest over the original vesting period instead of being forfeited upon separation, resulting in a revaluation of the awards and acceleration of expense.

Acquisition-related contingencies - During the three and nine months ended September 30, 2012, we increased the SmartDose contingent consideration by $0.5 million and $0.9 million, respectively, due to fair value adjustments. During the three and nine months ended September 30, 2011, we increased the SmartDose contingent consideration by $0.2 million and $0.3 million, respectively, due to fair value adjustments. In addition, during the nine months ended September 30, 2011, we reduced the éris contingent consideration by $0.8 million, bringing the liability balance to zero at June 30, 2011. This reduction reflects our assessment that none of the contractual operating targets will be achieved over the earnout period, which ends in 2014.

See Note 2, Restructuring and Other Items, for further discussion.

Operating Profit

The following table presents operating profit (loss) by reportable segment,
corporate and other unallocated costs:

                                          Three Months Ended         Nine Months Ended
                                            September 30,              September 30,
($ in millions)                            2012          2011        2012         2011
Segments:
Packaging Systems                      $    39.2       $ 34.8     $   143.4     $ 114.9
Delivery Systems                             4.7          1.7          12.5         5.9
Corporate and other unallocated items:
Corporate                                  (16.0 )       (9.1 )       (46.2 )     (32.2 )
Other unallocated expense                   (1.6 )       (1.3 )        (6.1 )      (6.0 )
Consolidated operating profit          $    26.3       $ 26.1     $   103.6     $  82.6


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