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WST > SEC Filings for WST > Form 10-Q on 6-May-2013All Recent SEC Filings

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Form 10-Q for WEST PHARMACEUTICAL SERVICES INC


6-May-2013

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 2012 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 2012 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 Packaging Systems and 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.

First Quarter 2013 Financial Performance Highlights

•         Net sales were $339.4 million, an increase of 7.3% from the same period
          in 2012 (7.2% excluding foreign currency effects).


•         Gross profit was $111.7 million, an increase of 10.5% from the same
          period in 2012, and our gross margin increased by one percentage point
          to 32.9%.


•         Operating profit was $43.3 million, an increase of 3.8% from the same
          period in 2012


•         Net income was $31.7 million, an increase of 8.6% from the same period
          in 2012.

We achieved higher net sales in both the Packaging Systems and Delivery Systems segments during the three months ended March 31, 2013, as compared to the same period in 2012. The overall sales growth was primarily the result of a favorable mix of products. Net sales originating in the United States were $150.6 million, an increase of 5.9% from the same period in 2012, primarily due to increases in Daikyo Crystal Zenith® ("CZ") and contract manufacturing sales and a higher domestic demand for pharmaceutical packaging components. Net sales generated outside of the United States were $188.8 million, an increase of 8.4% from the same period in 2012, reflecting continued growth and demand, particularly in Europe. Excluding the favorable effects from currency translation, our non-U.S. net sales increased 8.2% and our consolidated net sales increased 7.2% from the same period in 2012.


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Gross profit increased by $10.6 million during the three months ended March 31, 2013, as compared to the same period in 2012, primarily due to a favorable mix of products sold. Sales price increases and improved production efficiencies also increased gross profit, however, these favorable items were significantly offset by the impact of increased raw material costs and increased wages, benefits and other costs.

Operating profit increased by $1.6 million during the three months ended March 31, 2013, as compared to the same period in 2012, primarily due to the increase in consolidated gross profit described above, a decrease in restructuring and other items, and development income of approximately $0.3 million, partially offset by increases in R&D and SG&A costs and a charge of approximately $0.7 million related to the devaluation of the Venezuelan bolivar.

Net income increased by $2.5 million, and diluted net income per share increased by $0.09 per diluted share, during the three months ended March 31, 2013, as compared to the same period in 2012. Net income and diluted net income per share for the three months ended March 31, 2013 included a loss on extinguishment of debt of $0.2 million, or $0.01 per diluted share, resulting from a repurchase of our Convertible Debentures, and a discrete tax benefit of $1.3 million, or $0.04 per diluted share, related to the reinstatement of the Research and Development tax credit in January 2013. Net income and diluted net income per share for the three months ended March 31, 2012 included $0.7 million, or $0.02 per diluted share, in restructuring and related charges, an increase in acquisition-related contingencies, and a discrete tax charge.

Business Outlook

We anticipate continued revenue improvement driven by customers moving up the product quality and value scale in Packaging Systems and increasing growth in Delivery Systems' proprietary products, as customers accelerate their pre-commercial efforts. In particular, we continue to focus on the expansion of our high-value closure products and proprietary delivery systems, including CZ-based containment systems. We continue to believe that actions taken in recent years to increase capacity for certain products, reduce costs through restructuring and lean savings efforts, and expand into emerging markets will lead to improved profitability as global demand increases. We plan to continue funding capital projects related to new products, expansion activity, and emerging markets for Packaging Systems and for new, proprietary products within Delivery Systems. We believe that our operating results and financial position give us a platform for sustained growth, and will enable us to take advantage of opportunities to invest in our business as they arise.

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.


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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. 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
                                      March 31,
($ in millions)                    2013         2012
Packaging Systems              $   251.5      $ 235.7
Delivery Systems                    88.2         80.7
Intersegment sales elimination      (0.3 )       (0.1 )
Consolidated net sales         $   339.4      $ 316.3

Packaging Systems - Packaging Systems' net sales increased by $15.8 million, or 6.7%, for the three months ended March 31, 2013, as compared to the same period in 2012, including a favorable foreign exchange impact of $0.3 million. Excluding foreign exchange effects, net sales for the three months ended March 31, 2013 increased by $15.5 million, or 6.6%, as compared to the same period in 2012, primarily due to continued strong growth in sales of our higher-quality product offerings that reduce particulate contamination and create efficiencies in our customer's manufacturing processes, including ready-to-use seals, stoppers and plungers and FluroTec™-coated closures. Sales price increases contributed 2.4 percentage points of the increase.

Delivery Systems - Delivery Systems' net sales increased by $7.5 million, or 9.2%, for the three months ended March 31, 2013, as compared to the same period in 2012, including a favorable foreign exchange impact of $0.1 million. Excluding foreign exchange effects, net sales for the three months ended March 31, 2013 increased by $7.4 million, or 9.1%, as compared to the same period in 2012, primarily due to increases in CZ sales, contract manufacturing sales, and administration systems sales. Sales price increases contributed one percentage point of the increase.

Consolidated net sales increased by $23.1 million, or 7.3%, for the three months ended March 31, 2013, as compared to the same period in 2012, including a favorable foreign exchange impact of $0.4 million. Excluding foreign currency effects, net sales for the three months ended March 31, 2013 increased by $22.7 million, or 7.2%, as compared to the same period in 2012.

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
                                 March 31,
($ in millions)               2013         2012
Packaging Systems:
Gross Profit              $    94.8      $  85.2
Gross Margin                   37.7 %       36.1 %
Delivery Systems:
Gross Profit              $    16.9      $  15.9
Gross Margin                   19.1 %       19.7 %
Consolidated Gross Profit $   111.7      $ 101.1
Consolidated Gross Margin      32.9 %       31.9 %

Packaging Systems - Packaging Systems' gross profit increased by $9.6 million, or 11.3%, for the three months ended March 31, 2013, as compared to the same period in 2012, including a favorable foreign exchange impact of $0.2 million. Packaging Systems' gross margin increased by 1.6 percentage points for the three months ended March 31, 2013, as compared to the same period in 2012, primarily as a result of a favorable mix of products sold. Sales price increases and improved production efficiencies also increased Packaging Systems' gross margin, however, these favorable items were substantially offset by the impact of increased raw material costs and increased wages, benefits and other costs.

Delivery Systems - Delivery Systems' gross profit increased by $1.0 million, or 6.3%, for the three months ended March 31, 2013, as compared to the same period in 2012. Delivery Systems' gross margin decreased by 0.6 percentage points for the three months ended March 31, 2013, as compared to the same period in 2012, primarily due to the gross margin for the three months ended March 31, 2012, which included a cost reimbursement payment from a customer for previously-incurred costs.

Consolidated gross profit increased by $10.6 million, or 10.5%, for the three months ended March 31, 2013, as compared to the same period in 2012, including a favorable foreign exchange impact of $0.2 million. Consolidated gross margin increased by one percentage point for the three months ended March 31, 2013, as compared to the same period in 2012.

Research and Development ("R&D") Costs

                            Three Months Ended
                                March 31,
($ in millions)               2013            2012
Packaging Systems      $     3.5             $ 3.2
Delivery Systems             5.6               5.1
Consolidated R&D Costs $     9.1             $ 8.3


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Packaging Systems' R&D costs increased by $0.3 million, or 9.4%, for the three months ended March 31, 2013, as compared to the same period in 2012, primarily as a result of increased investment in next-generation packaging components.

Delivery Systems' R&D costs increased by $0.5 million, or 9.8%, for the three months ended March 31, 2013, as compared to the same period in 2012, primarily as a result of development work on the SmartDose electronic patch injector system.

Consolidated R&D costs increased by $0.8 million, or 9.6%, for the three months ended March 31, 2013, as compared to the same period in 2012.

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

                            Three Months Ended
                                March 31,
($ in millions)              2013          2012
Packaging Systems        $    32.1       $ 28.9
Delivery Systems              10.5          8.8
Corporate                     16.5         13.6
Consolidated SG&A costs  $    59.1       $ 51.3
SG&A as a % of net sales      17.4 %       16.2 %

Packaging Systems' SG&A costs increased by $3.2 million, or 11.1%, for the three months ended March 31, 2013, as compared to the same period in 2012, primarily as a result of an increase in other compensation costs related to annual compensation increases and headcount increases and incremental costs related to information technology projects and outside services, such as supply chain initiatives, all of which were partially offset by foreign currency translation effects, which decreased Packaging Systems' SG&A costs by $0.2 million.

Delivery Systems' SG&A costs increased by $1.7 million, or 19.3%, for the three months ended March 31, 2013, as compared to the same period in 2012, primarily as a result of an increase in other compensation costs related to annual compensation increases and headcount increases and incremental costs related to outside services, such as legal costs and sales commissions.

Corporate's SG&A costs increased by $2.9 million, or 21.3%, for the three months ended March 31, 2013, as compared to the same period in 2012, primarily due to increases in stock-based compensation expense and intellectual property-related costs. The increase in stock-based compensation expense of $2.2 million was primarily due to the impact of higher share prices on our deferred compensation plan liabilities, which are indexed to our share price.

Consolidated SG&A costs increased by $7.8 million, or 15.2%, for the three months ended March 31, 2013, as compared to the same period in 2012.


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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
                                                    March 31,
($ in millions) Expense (income)                 2013           2012
Segments                                   $    0.2           $ (0.8 )
Corporate and other unallocated items:
Restructuring and related charges                 -              0.4
Acquisition-related contingencies                 -              0.2
Consolidated restructuring and other items $    0.2           $ (0.2 )

Other income and expense items, consisting primarily of foreign exchange transaction gains and losses, gains and losses on the sale of fixed assets, and miscellaneous income and charges, such as development income and the charge related to the devaluation of the Venezuelan bolivar, 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 months ended March 31, 2012, we incurred restructuring and related charges of $0.4 million associated with the 2010 plan. Charges incurred during the three months ended March 31, 2012 were primarily facility closure costs associated with a reduction of operations at a manufacturing facility in England and the 2011 closure of a plant in the United States. We do not expect to incur any future charges related to the 2010 plan, and the remaining restructuring obligations at March 31, 2013 will be reduced to zero as payments are made.

During the three months ended March 31, 2013, we increased the SmartDose contingent consideration by an immaterial amount due to fair value adjustments. During the three months ended March 31, 2012, we increased the SmartDose contingent consideration by $0.2 million due to fair value adjustments.

Operating Profit

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

                                          Three Months Ended
                                              March 31,
($ in millions)                            2013          2012
Segments:
Packaging Systems                      $    58.6       $ 53.6
Delivery Systems                             1.2          2.3
Corporate and other unallocated items:
Corporate                                  (16.5 )      (13.6 )
Other unallocated expense                      -         (0.6 )
Consolidated operating profit          $    43.3       $ 41.7


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Packaging Systems - Packaging Systems' operating profit increased by $5.0 million, or 9.3%, for the three months ended March 31, 2013, as compared to the same period in 2012, including a favorable foreign exchange impact of $0.4 million, due to the factors described above.

Delivery Systems - Delivery Systems' operating profit decreased by $1.1 million, or 47.8%, for the three months ended March 31, 2013, as compared to the same period in 2012, due to the factors described above.

Corporate - Corporate's operating loss increased by $2.9 million, or 21.3%, for the three months ended March 31, 2013, as compared to the same period in 2012, due to the factors described above.

Consolidated operating profit increased by $1.6 million, or 3.8%, for the three months ended March 31, 2013.

Loss on Debt Extinguishment

During the three months ended March 31, 2013, we repurchased $1.7 million in aggregate principal amount of our Convertible Debentures, resulting in a pre-tax loss on debt extinguishment of $0.2 million, the majority of which consisted of the premium over par value.

Interest Expense, Net

The following table presents interest expense, net, by significant component:

                         Three Months Ended
                              March 31,
($ in millions)          2013           2012
Interest expense      $    4.8       $    4.7
Capitalized interest      (0.2 )         (0.4 )
Interest income           (0.6 )         (0.4 )
Interest expense, net $    4.0       $    3.9

Interest expense, net, increased by $0.1 million, or 2.6%, for the three months ended March 31, 2013, as compared to the same period in 2012, primarily due to decreased capitalized interest resulting from the completion of certain capital projects.

Income Taxes

The provision for income taxes was $8.6 million and $9.8 million for the three months ended March 31, 2013 and 2012, respectively, resulting in effective tax rates of 22.0% and 26.1%, respectively. The decrease in the effective tax rate for the three months ended March 31, 2013 primarily reflects the impact of a discrete tax benefit of $1.3 million related to the reinstatement of the Research and Development tax credit in January 2013. In accordance with U.S. GAAP, although the tax credit was reinstated on a retroactive basis to January 1, 2012, the credit was not taken into account for financial reporting purposes until 2013. During the three months ended March 31, 2012, we recorded a $0.3 million reduction of our deferred tax assets associated with the legal restructuring of the ownership of our Puerto Rico operations.

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 $1.2 million for each of the three months ended March 31, 2013 and 2012.


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Net Income

Net income for the three months ended March 31, 2013 was $31.7 million, which included a loss on extinguishment of debt of $0.2 million and a discrete tax benefit of $1.3 million. Net income for the three months ended March 31, 2012 was $29.2 million, which included restructuring and related charges of $0.3 million (net of $0.1 million in tax), an increase in acquisition-related contingencies of $0.1 million (net of $0.1 million in tax), and a discrete tax charge of $0.3 million.

FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

Cash Flows

The following table presents cash flow data for the three months ended March 31:

($ in millions)                             2013       2012
Net cash provided by operating activities $ 18.9     $ 13.8
Net cash used in investing activities      (57.7 )    (31.9 )
Net cash provided by financing activities   55.5       24.2

Net Cash Provided by Operating Activities - Net cash provided by operating activities for the three months ended March 31, 2013 was $18.9 million, an increase of $5.1 million from the same period in 2012. Net cash provided by operating activities for the three months ended March 31, 2013 increased primarily due to the increase in net income and a lower level of pension funding, both of which were partially offset by higher working capital requirements.

Net Cash Used in Investing Activities - Net cash used in investing activities for the three months ended March 31, 2013 was $57.7 million, an increase of $25.8 million from the same period in 2012. Net cash used in investing activities for the three months ended March 31, 2013 increased primarily due to a $29.3 million increase in capital spending, to $61.7 million, for the three months ended March 31, 2013. The majority of the increased capital spending was related to construction of our new corporate office and research building, which began in 2011 and settled in February 2013, information technology infrastructure improvements, and construction of our new compression-molding plant in China, for which we expect commercial production to begin by mid-year 2013. The capital spending increase was partially offset by the change in our short-term investment activity. During the three months ended March 31, 2013, we sold $9.6 million, and purchased $5.4 million, of short-term investments. During the three months ended March 31, 2012, we sold $4.8 million, and purchased $4.6 million, of short-term investments. The short-term investments represent certificates of deposit, primarily in Israel, with maturities between three and nine months.

Net Cash Provided by Financing Activities - Net cash provided by financing activities for the three months ended March 31, 2013 was $55.5 million, an increase of $31.3 million from the same period in 2012. Net cash provided by financing activities for the three months ended March 31, 2013 increased primarily as we borrowed $42.8 million to finance the construction and acquisition of our new corporate office and research building and as we entered into Euro-denominated debt of $27.4 million under our multi-currency revolving credit facility. Both increases were partially offset by our $26.6 million repayment of Euro note A. We used cash generated from operations and net borrowings to fund the repurchase of our Convertible Debenture, working capital needs, capital expenditures, and to pay dividends.


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Liquidity and Capital Resources

The table below presents selected liquidity and capital measures:

($ in millions)                     March 31, 2013     December 31, 2012
Cash and cash equivalents          $       175.0      $           161.9
Short-term investments                       8.2                   12.4
Working capital                            381.6                  295.5
Total debt                                 430.1                  411.5
Total equity                               745.9                  728.9
Net debt-to-total invested capital          25.5 %                 25.5 %

Cash and cash equivalents include all instruments that have maturities of ninety days or less when purchased. Short-term investments include all instruments that have maturities between ninety-one days and one year 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.

Cash and cash equivalents - Our cash and cash equivalents balance at March 31, 2013 consisted of cash held in cash depository accounts with banks around the world and cash invested in high quality, short-term investments. The cash and cash equivalents balance at March 31, 2013 included $162.3 million of cash held by subsidiaries outside of the United States, primarily in Germany, Israel, and Singapore, which is available to fund operations and growth of non-U.S. subsidiaries. Bringing the cash into the United States could trigger U.S. federal, state and local income tax obligations; however, we may temporarily access cash held by our non-U.S. subsidiaries without becoming subject to U.S. income tax by entering into short-term intercompany loans. . . .

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