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WST > SEC Filings for WST > Form 10-Q on 8-May-2014All Recent SEC Filings

Show all filings for WEST PHARMACEUTICAL SERVICES INC

Form 10-Q for WEST PHARMACEUTICAL SERVICES INC


8-May-2014

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 2013 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 2013 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.

On August 1, 2013, our Board of Directors approved a two-for-one stock split of our outstanding shares of common stock, effected in the form of a stock dividend. The record date for the stock split was September 12, 2013, and the share distribution occurred on September 26, 2013. All share and per share amounts presented in the accompanying condensed consolidated financial statements and related notes have been retroactively adjusted to reflect the impact of the stock split.

First Quarter 2014 Financial Performance Highlights and Business Outlook
Net sales were $346.8 million, an increase of 2.2% from the same period in 2013. Excluding foreign currency effects, net sales increased by $4.1 million, or 1.2%.

         Gross profit was $106.4 million, a decrease of 4.7% from the same
          period in 2013, and our gross margin decreased by 2.2 margin points to
          30.7%.


         Operating profit was $39.3 million, a decrease of 9.2% from the same
          period in 2013, and our operating profit margin decreased by 1.5 margin
          points to 11.3%.


         Net income was $27.1 million, or $0.38 per diluted share, compared to
          $31.7 million, or $0.45 per diluted share, in the same period in 2013.


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Although we achieved higher net sales during the three months ended March 31, 2014, as compared to the same period in 2013, sales of Packaging Systems' high-value product offerings and Delivery Systems' proprietary products declined during the three months ended March 31, 2014, as compared to the same period in 2013. The decrease in sales of Packaging System's high-value product offerings was mostly a result of the strong sales for the three months ended March 31, 2013, primarily due to customers' strategic inventory building, customers increasing orders in response to drug shortages, and new product launches. The decrease in sales of Delivery Systems' proprietary products was mainly due to decreases in sales of safety systems and CZ, partially offset by an increase in sales of SmartDose cartridges. The unfavorable mix of products sold, both in Packaging Systems and Delivery Systems, was a primary factor for the decrease in gross profit and net income per share during the three months ended March 31, 2014, as compared to the same period in 2013.

The decline in our results during the three months ended March 31, 2014, as compared to the same period in 2013, was not unexpected, and we expect growth in net sales and operating profit for the full year ending December 31, 2014, as compared to the year ended December 31, 2013. We anticipate continued revenue and margin improvement on a long-term basis, driven by customers' increasing demand for higher product quality, which results in higher revenues and margin per unit sold in Packaging Systems and an increasing percentage of total sales from higher margin proprietary products in Delivery 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 investment in emerging markets for Packaging Systems and new proprietary products within Delivery Systems. We believe that our strong 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.

For the purpose of aiding the comparison of our year-over-year results, we may refer to net sales and other financial results excluding the effects of changes in foreign currency exchange rates. The constant-currency amounts are calculated by translating the current year's functional currency results at the prior-year period's exchange rate. 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.


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Net Sales

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

                                  Three Months Ended
                                      March 31,
($ in millions)                    2014         2013
Packaging Systems              $   252.9      $ 251.5
Delivery Systems                    94.0         88.2
Intersegment sales elimination      (0.1 )       (0.3 )
Consolidated net sales         $   346.8      $ 339.4

Consolidated net sales increased by $7.4 million, or 2.2%, for the three months ended March 31, 2014, as compared to the same period in 2013, including a favorable foreign currency impact of $3.3 million. Excluding foreign currency effects, net sales for the three months ended March 31, 2014 increased by $4.1 million, or 1.2%, as compared to the same period in 2013.

Consolidated net sales originating in the United States were $150.3 million, a decrease of 0.2% from the same period in 2013. Consolidated net sales generated outside of the United States were $196.5 million, an increase of 4.1% from the same period in 2013.

Packaging Systems - Packaging Systems' net sales increased by $1.4 million, or 0.5% for the three months ended March 31, 2014, as compared to the same period in 2013, including a favorable foreign currency impact of $2.5 million for the three months ended March 31, 2014. Excluding foreign currency effects, net sales for the three months ended March 31, 2014 decreased by $1.1 million, or 0.4% as compared to the same period in 2013, primarily as a decrease in sales of our high-value product offerings was partially offset by an increase in our standard packaging component sales. The decrease in sales of Packaging Systems' high-value product offerings was mostly a result of the strong sales for the three months ended March 31, 2013, primarily due to customers' strategic inventory building, customers increasing orders in response to drug shortages, and new product launches. Sales price increases contributed 0.4 percentage points of the increase.

Delivery Systems - Delivery Systems' net sales increased by $5.8 million, or 6.6%, for the three months ended March 31, 2014, as compared to the same period in 2013, including a favorable foreign currency impact of $0.9 million. Excluding foreign currency effects, net sales for the three months ended March 31, 2014 increased by $4.9 million, or 5.6%, as compared to the same period in 2013, primarily due to an increase in contract manufacturing sales, which was partially offset by a decrease in our proprietary net sales. The decrease in sales of Delivery Systems' proprietary products was mainly due to decreases in sales of safety systems and CZ, partially offset by an increase in sales of SmartDose cartridges. Proprietary net sales represented 22.5% of Delivery Systems' net sales for the three months ended March 31, 2014, as compared to 25.3% for the same period in 2013. Sales price increases contributed 1.1 percentage points of the increase.

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)               2014         2013
Packaging Systems:
Gross Profit              $    89.4      $  94.8
Gross Margin                   35.4 %       37.7 %
Delivery Systems:
Gross Profit              $    17.0      $  16.9
Gross Margin                   18.1 %       19.1 %
Consolidated Gross Profit $   106.4      $ 111.7
Consolidated Gross Margin      30.7 %       32.9 %

Consolidated gross profit decreased by $5.3 million, or 4.7%, for the three months ended March 31, 2014, as compared to the same period in 2013, despite a favorable foreign currency impact of $0.8 million for the three months ended March 31, 2014. Consolidated gross margin decreased by 2.2 margin points for the three months ended March 31, 2014, as compared to the same period in 2013.

Packaging Systems - Packaging Systems' gross profit decreased by $5.4 million, or 5.7% for the three months ended March 31, 2014, respectively, as compared to the same period in 2013, despite a favorable foreign currency impact of $0.7 million for the three months ended March 31, 2014. Packaging Systems' gross margin decreased by 2.3 margin points for the three months ended March 31, 2014, as compared to the same period in 2013, primarily as a result of the unfavorable mix of products sold, production inefficiencies, and increased wages, benefits and other costs, all of which were partially offset by raw material cost decreases and sales price increases.

Delivery Systems - Delivery Systems' gross profit increased by $0.1 million, or 0.6%, for the three months ended March 31, 2014, as compared to the same period in 2013, including a favorable foreign currency impact of $0.1 million. Delivery Systems' gross margin decreased by 1.0 margin point for the three months ended March 31, 2014, as compared to the same period in 2013, primarily as a result of the unfavorable mix of products sold and the impact of wage, benefit and other cost increases, all of which were partially offset by production efficiencies and sales price increases.

R&D Costs
                            Three Months Ended
                                 March 31,
($ in millions)                2014            2013
Packaging Systems      $       4.3            $ 3.5
Delivery Systems               5.7              5.6
Consolidated R&D Costs $      10.0            $ 9.1

Consolidated R&D costs increased by $0.9 million, or 9.9%, for the three months ended March 31, 2014 as compared to the same period in 2013.

Packaging Systems - Packaging Systems' R&D costs increased by $0.8 million, or 22.9%, for the three months ended March 31, 2014 as compared to the same period in 2013, primarily as a result of increased investment in next-generation packaging components.


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Delivery Systems - Delivery Systems' R&D costs increased by $0.1 million, or 1.8%, for the three months ended March 31, 2014, as compared to the same period in 2013, primarily as a result of continued development work on a variety of proprietary products.

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

                            Three Months Ended
                                March 31,
($ in millions)              2014          2013
Packaging Systems        $    32.9       $ 32.1
Delivery Systems              11.6         10.5
Corporate                     11.9         16.5
Consolidated SG&A costs  $    56.4       $ 59.1
SG&A as a % of net sales      16.2 %       17.4 %

Consolidated SG&A costs decreased by $2.7 million, or 4.6%, for the three months ended March 31, 2014, as compared to the same period in 2013. Consolidated SG&A costs were 16.2% and 17.4% of consolidated net sales for the three months ended March 31, 2014 and 2013, respectively.

Packaging Systems - Packaging Systems' SG&A costs increased by $0.8 million, or 2.5%, for the three months ended March 31, 2014, as compared to the same period in 2013, primarily as a result of increased compensation costs mostly related to headcount and merit increases and incentive compensation cost increases, both of which were partially offset by a decrease in consulting costs.

Delivery Systems - Delivery Systems' SG&A costs increased by $1.1 million, or 10.5%, for the three months ended March 31, 2014, as compared to the same period in 2013, primarily as a result of increased compensation costs mainly related to headcount and merit increases and incremental depreciation and amortization expense.

Corporate - Corporate's SG&A costs decreased by $4.6 million, or 27.9%, for the three months ended March 31, 2014, as compared to the same period in 2013, primarily due to a $1.8 million decrease in the U.S. pension expense, a $1.1 million decrease in stock-based compensation expense, a $0.8 million decrease in incentive compensation costs, and a $0.6 million decrease in intellectual property-related costs. The decrease in stock-based compensation expense was primarily due to the impact of lower share prices on our incentive and deferred compensation plan liabilities, which are indexed to our share price.

Other Expense

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

                                         Three Months Ended
Expense (income)                              March 31,
($ in millions)                          2014           2013
Packaging Systems                     $    0.8       $    0.6
Delivery Systems                          (0.1 )         (0.4 )
Corporate and other unallocated items        -              -
Consolidated other expense            $    0.7       $    0.2


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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, 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, 2014, we recognized development income of $0.4 million within Delivery Systems related to a nonrefundable payment of $20.0 million received from a customer in June 2013 in return for the exclusive use of SmartDose within a specific therapeutic area. Unearned income related to this payment of $1.5 million and $17.1 million was included within other current liabilities and other long-term liabilities, respectively, at March 31, 2014. The unearned income is being recognized as development 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. During the three months ended March 31, 2013, we recorded development income of $0.3 million within Delivery Systems.

During the three months ended March 31, 2014, we increased the SmartDose contingent consideration by $0.4 million due to the time value of money and adjustments related to changes in sales projections. During the three months ended March 31, 2013, we increased the SmartDose contingent consideration by an immaterial amount due to the same factors described above. These adjustments are included within Delivery Systems' results.

Since February 2013, when the Venezuelan government announced a devaluation of the bolivar, we have used the official exchange rate of 6.3 bolivars to the U.S. dollar to re-measure our Venezuelan subsidiary's financial statements in U.S. dollars. Beginning in December 2013, the Venezuelan government announced a series of changes to the regulations governing its currency exchange market, which included the expanded use of a recently-created currency exchange mechanism and the creation of a third currency exchange mechanism. As the majority of our currency purchases are transacted at the official exchange rate of 6.3 bolivars per U.S. dollar, we have continued to re-measure our Venezuelan subsidiary's financial statements using the official rate. At March 31, 2014, we had $2.7 million in net monetary assets denominated in Venezuelan bolivars, including $1.6 million in cash and cash equivalents. If we determine that we should use one of the other currency exchange mechanisms in Venezuela in the future, or if there is a significant devaluation in the official exchange rate, a pre-tax charge up to the amount of our Venezuelan subsidiary's net monetary assets denominated in bolivars could be required. We will continue to actively monitor the political and economic developments in Venezuela.

Operating Profit

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

                                          Three Months Ended
                                              March 31,
($ in millions)                            2014          2013
Segments:
Packaging Systems                      $    51.4       $ 58.6
Delivery Systems                            (0.2 )        1.2
Corporate and other unallocated items:
Corporate                                  (11.9 )      (16.5 )
Other unallocated expense                      -            -
Consolidated operating profit          $    39.3       $ 43.3
Consolidated operating profit margin        11.3 %       12.8 %


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Consolidated operating profit decreased by $4.0 million, or 9.2%, for the three months ended March 31, 2014, as compared to the same period in 2013, despite a favorable foreign currency impact of $0.6 million. Consolidated operating profit margin decreased by 1.5 margin points for the three months ended March 31, 2014, as compared to the same period in 2013.

Packaging Systems - Packaging Systems' operating profit decreased by $7.2 million, or 12.3%, for the three months ended March 31, 2014, as compared to the same period in 2013, despite a favorable foreign currency impact of $0.5 million, due to the factors described above.

Delivery Systems - Delivery Systems' operating profit decreased by $1.4 million, or 116.7%, for the three months ended March 31, 2014, as compared to the same period in 2013, despite a favorable foreign currency impact of $0.1 million, due to the factors described above.

Corporate - Corporate costs decreased by $4.6 million, or 27.9%, for the three months ended March 31, 2014, as compared to the same period in 2013, due to the factors described above.

Loss on Debt Extinguishment

During the three months ended March 31, 2013, we repurchased $1.7 million in aggregate principal amount of our convertible debt, 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)          2014           2013
Interest expense      $    4.5       $    4.8
Capitalized interest      (0.5 )         (0.2 )
Interest income           (0.4 )         (0.6 )
Interest expense, net $    3.6       $    4.0

Interest expense, net, decreased by $0.4 million, or 10.0%, for the three months ended March 31, 2014, as compared to the same period in 2013, primarily due to a decrease in interest expense resulting from less debt outstanding during the three months ended March 31, 2014, as compared to the three months ended March 31, 2013, and an increase in capitalized interest mainly due to capital projects in the United States and Asia.

Income Taxes

The provision for income taxes was $9.8 million and $8.6 million for the three months ended March 31, 2014 and 2013, respectively, resulting in effective tax rates of 27.6% and 22.0%, respectively. The increase in the effective tax rate for the three months ended March 31, 2014 primarily reflects the absence of the R&D tax credit in 2014, changes in our geographic mix of earnings, and the impact of the discrete tax item discussed below. The R&D tax credit was retroactively reinstated in January 2013 for two years, from January 1, 2012 through December 31, 2013, as a result of the enactment of the Taxpayer Relief Act.


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During the three months ended March 31, 2013, we recorded a discrete tax benefit of $1.3 million related to the R&D tax credit. In accordance with U.S. GAAP, although the Taxpayer Relief Act reinstated the tax credit on a retroactive basis to January 1, 2012, the credit was not taken into account for financial reporting purposes until 2013.

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 remained constant at $1.2 million for the three months ended March 31, 2014, as compared to the same period in 2013, as favorable operating results in Mexico were offset by a decrease in Daikyo mostly related to foreign currency effects.

Net Income

Net income for the three months ended March 31, 2014 was $27.1 million. 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.

FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

Cash Flows

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

($ in millions)                             2014       2013
Net cash provided by operating activities $  8.8     $ 18.9
Net cash used in investing activities      (35.6 )    (57.7 )
Net cash provided by financing activities   26.2       55.5

Net Cash Provided by Operating Activities - Net cash provided by operating activities for the three months ended March 31, 2014 was $8.8 million, a decrease of $10.1 million from the same period in 2013. Net cash provided by operating activities for the three months ended March 31, 2014 decreased primarily due to the decrease in net income, higher working capital requirements, and increased income tax payments.

Net Cash Used in Investing Activities - Net cash used in investing activities for the three months ended March 31, 2014 was $35.6 million, a decrease of $22.1 million from the same period in 2013. Net cash used in investing activities for the three months ended March 31, 2014 decreased primarily due to a $30.0 million decrease in capital spending, to $31.7 million, mainly as the construction of our new corporate office and research building was settled in February 2013. The majority of the capital spending for the three months ended March 31, 2014 related to new products, expansion activity, and emerging markets, including capital projects in the U.S., India and China. The capital spending decrease was partially offset by the change in our short-term investment activity. During the three months ended March 31, 2014, we purchased $9.2 million, and sold $5.0 million, of short-term investments. During the three months ended March 31, 2013, we purchased $5.4 million, and sold $9.6 million, of short-term investments. The short-term investments represent certificates of deposit, primarily in Israel, with maturities between ninety-one days and one year at the time of purchase.


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Net Cash Provided by Financing Activities - Net cash provided by financing activities for the three months ended March 31, 2014 was $26.2 million, a decrease of $29.3 million from the same period in 2013. Net cash provided by financing activities for the three months ended March 31, 2014 decreased primarily due to a reduction in our net debt activity and a $3.1 million . . .

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