SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

(Mark One)

x                              QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2007

o                                 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from            to            

Commission File Number 1-8036

WEST PHARMACEUTICAL SERVICES, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Registrant’s telephone number, including area code: 610-594-2900

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes x   No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filed.  See definition of “accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.

 

Indicated by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Exchange Act).   Yes o   No x

As of June 30, 2007, there were 33,148,604 shares of the Registrant’s common stock outstanding.

 

 

 

TABLE OF CONTENTS

		Page
CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS		3
PART I. FINANCIAL INFORMATION
ITEM 1.   FINANCIAL STATEMENTS (UNAUDITED)
Condensed Consolidated Statements of Income for the Three and Six Month Periods ended June 30, 2007 and 2006		4
Condensed Consolidated Balance Sheets at June 30, 2007 and December 31, 2006		5
Condensed Consolidated Statement of Shareholders’ Equity for the Six Months ended June 30, 2007		6
Condensed Consolidated Statements of Cash Flows for the Six Months ended June 30, 2007 and 2006		7
Notes to Condensed Consolidated Financial Statements		8
ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS		14
ITEM 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK		24
ITEM 4.   CONTROLS AND PROCEDURES		24
PART II. OTHER INFORMATION
ITEM 2.   UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS		25
ITEM 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS		25
ITEM 6.   EXHIBITS		25
SIGNATURES		26
INDEX TO EXHIBITS		F-1

 

 

 

CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS

(Cautionary Statements Under the Private Securities Litigation Reform Act of 1995)

Our disclosure and analysis in this Form 10-Q contains some forward-looking statements that set forth anticipated results based on management’s plans and assumptions.  Such statements give our current expectations or forecasts of future events — they do not relate strictly to historical or current facts. In particular, these include statements concerning future actions, future performance or results of current and anticipated products, sales efforts, expenses, the outcome of contingencies such as legal proceedings and financial results. We have tried, wherever possible, to identify such statements by using words such as “estimate,” “expect,” “intend,” “believe,” “plan,” “anticipate” and other words and terms of similar meaning in connection with any discussion of future operating or financial performance or condition.

We cannot guarantee that any forward-looking statement will be realized. If known or unknown risks or uncertainties materialize, or if underlying assumptions are inaccurate, actual results could differ materially from past results and those expressed or implied in any forward-looking statement.  You should bear this in mind as you consider forward-looking statements. We cannot predict or identify all such risks and uncertainties, but factors that could cause the actual results to differ materially from expected and historical results include the following:  sales demand; the timing, regulatory approval and commercial success of customers’ products incorporating our products and services, including specifically, the Exubera® Inhalation-Powder insulin device; customers’ changes to inventory requirements and manufacturing plans that alter existing orders or ordering patterns for our products; our ability to pass raw-material cost increases on to customers through price increases; maintaining or improving production efficiencies and overhead absorption; physical limits on manufacturing capacity that may limit our ability to satisfy anticipated demand; the timeliness and effects of capacity expansions, including the effects of delays associated with construction, availability and price of capital goods, and necessary internal, governmental and customer approvals; the availability of labor to meet increased demand; competition from other providers; the timely and successful negotiations of sales contracts with four of the Company’s largest customers during the second half of 2007; average profitability, or mix, of products sold in a reporting period; financial performance of unconsolidated affiliates; strength of the U.S. dollar in relation to other currencies, particularly the Euro, UK Pound, Danish Krone, Japanese Yen and Singapore Dollar; changing interest rates and investment returns that can affect the Company’s cost of funds and return on invested funds; interruptions or weaknesses in our supply chain, which could cause delivery delays or restrict the availability of raw materials and key bought-in components and finished products; raw-material price escalation, particularly petroleum-based raw materials, and energy costs; availability, and pricing of materials that may be affected by vendor concerns with exposure to product-related liability; and, changes in tax law or loss of beneficial tax incentives.

We also refer you to the risks associated with our business that are contained in our Annual Report on Form 10-K under the caption “RISK FACTORS”, as supplemented from time to time in subsequently filed Quarterly Reports on Form 10-Q, and other documents we may file with the Securities and Exchange Commission. We undertake no obligation to publicly update forward-looking statements, whether as a result of new information, future events or otherwise.

All trademarks and registered trademarks used in this report are the property of West Pharmaceutical Services, Inc. and its subsidiaries, unless noted otherwise.

Exubera® is a registered trademark of Pfizer Inc.

 

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PART I.   FINANCIAL INFORMATION

ITEM 1.   FINANCIAL STATEMENTS

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
West Pharmaceutical Services, Inc. and Subsidiaries

				Three Months Ended June 30,						Six Months Ended June 30,
(in millions, except per share data)				2007			2006			2007			2006
Net sales				$	263.7		$	240.2		$	521.3		$	463.0
Cost of goods sold				187.0			169.1			364.2			324.2
Gross profit				76.7			71.1			157.1			138.8
Research and development				3.8			2.6			7.4			5.1
Selling, general and administrative expenses				38.2			34.9			75.2			71.2
Other (income) expense, net				(0.2		)	1.5			0.1			2.2
Operating profit				34.9			32.1			74.4			60.3
Loss on debt extinguishment				—			—			—			5.9
Interest expense				3.9			3.3			6.7			7.0
Interest income				(2.2		)	(0.5		)	(2.8		)	(1.2		)
Income before income taxes and minority interests				33.2			29.3			70.5			48.6
Provision for income taxes				7.0			9.2			18.2			14.5
Minority interests				0.1			0.1			0.2			0.2
Income from consolidated operations				26.1			20.0			52.1			33.9
Equity in net income of affiliated companies				0.4			0.7			0.9			1.1
Income from continuing operations				26.5			20.7			53.0			35.0
Discontinued operations, net of tax				(0.5		)	—			(0.5		)	3.8
Net income				$	26.0		$	20.7		$	52.5		$	38.8
Net income per share:
Basic
Continuing operations				$	0.80		$	0.64		$	1.61		$	1.10
Discontinued operations				(0.01		)	—			(0.01		)	0.12
				$	0.79		$	0.64		$	1.60		$	1.22
Assuming dilution:
Continuing operations				$	0.74		$	0.62		$	1.51		$	1.05
Discontinued operations				(0.01		)	—			(0.01		)	0.11
				$	0.73		$	0.62		$	1.50		$	1.16
Average common shares outstanding				32.9			32.1			32.8			31.9
Average shares assuming dilution				37.1			33.6			35.8			33.4
Dividends declared per common share				$	—	*	$	0.12		$	0.13		$	0.24

 

*                    $0.13 dividend was declared on July 10, 2007 and will be paid on August 1, 2007 to shareholders of record on July 18, 2007.

See accompanying notes to condensed consolidated financial statements.

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CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
West Pharmaceutical Services, Inc. and Subsidiaries

(in millions)				June 30, 2007			December 31, 2006
ASSETS
Current assets:
Cash, including cash equivalents				$	177.3		$	47.1
Accounts receivable				136.7			109.5
Inventories				111.7			97.5
Deferred income taxes				5.6			5.3
Other current assets				21.0			22.3
Total current assets				452.3			281.7
Property, plant and equipment				807.2			757.4
Less accumulated depreciation and amortization				398.7			372.7
Property, plant and equipment, net				408.5			384.7
Investments in affiliated companies				29.9			29.7
Goodwill				103.8			102.8
Pension asset				10.7			12.1
Deferred income taxes				47.2			29.8
Intangible assets, net				67.9			66.3
Other assets				22.4			11.1
Total Assets				$	1,142.7		$	918.2
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Notes payable and other current debt				$	0.5		$	0.5
Accounts payable				53.5			61.2
Pension and other postretirement benefits				1.7			1.6
Accrued salaries, wages and benefits				34.9			35.3
Income taxes payable				19.3			17.7
Deferred income taxes				2.2			2.7
Other current liabilities				37.0			37.9
Total current liabilities				149.1			156.9
Long-term debt				384.2			235.8
Deferred income taxes				43.0			43.5
Pension and other postretirement benefits				42.8			41.2
Other long-term liabilities				24.5			21.5
Total Liabilities				643.6			498.9
Commitments and contingencies				—			—
Minority interests				4.9			4.8
Shareholders’ equity				494.2			414.5
Total Liabilities and Shareholders’ Equity				$	1,142.7		$	918.2

 

See accompanying notes to condensed consolidated financial statements.

5

CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY (UNAUDITED)
West Pharmaceutical Services, Inc. and Subsidiaries

															Accumulated
				Common Stock					Capital in						other			Treasury Stock
				Number		Common			excess of			Retained			comprehensive			Number		Treasury
(in millions, except per share data)				of shares		Stock			par value			earnings			income (loss)			of shares		Stock			Total
Balance, December 31, 2006				34.3		$	8.6		$	52.8		$	375.7		$	10.6		(1.4	)	$	(33.2	)	$	414.5
Cumulative effect of adoption of FIN 48  (see Note 4)												21.6											21.6
Net income												52.5											52.5
Stock-based compensation									3.4														3.4
Shares issued under stock plans									1.7									0.3		1.4			3.1
Shares repurchased for employee tax withholdings									(1.0		)							(0.1	)	(2.6		)	(3.6		)
Excess tax benefit from stock plans									0.7														0.7
Cash dividends declared ($0.13 per share)												(4.3		)									(4.3		)
Changes — other comprehensive income															6.3								6.3
Balance, June 30, 2007				34.3		$	8.6		$	57.6		$	445.5		$	16.9		(1.2	)	$	(34.4	)	$	494.2

 

See accompanying notes to condensed consolidated financial statements.

6

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

West Pharmaceutical Services, Inc. and Subsidiaries

				Six Months Ended June 30,
(in millions)				2007			2006
Cash flows from operating activities:
Net income				$	52.5		$	38.8
Loss (gain) from discontinued operations, net of tax				0.5			(3.8		)
Depreciation				25.7			23.4
Amortization				2.6			2.4
Other non-cash items, net				4.5			10.8
Changes in assets and liabilities				(40.1		)	(18.1		)
Net cash provided by operating activities				45.7			53.5
Cash flows from investing activities:
Acquisition of patents and other assets				(4.2		)	—
Property, plant and equipment acquired				(45.1		)	(26.8		)
Proceeds from sale of investment				0.7			—
Other				—			0.3
Net cash used in investing activities				(48.6		)	(26.5		)
Cash flows from financing activities:
Issuance of 4% convertible debt, net of costs				156.4			—
Prepayment of senior notes				—			(100.0		)
Issuance of senior unsecured notes				—			100.1
Repayments under revolving credit agreements, net				(15.0		)	(27.8		)
Changes in other debt, including overdrafts				(0.4		)	0.2
Dividend payments				(8.6		)	(7.8		)
Excess tax benefit from stock option exercises				0.7			—
Shares repurchased for employee tax withholdings				(3.6		)	(1.3		)
Issuance of common stock				2.5			4.4
Net cash provided by (used in) financing activities				132.0			(32.2		)
Cash flows provided by operating activities of discontinued operations				—			0.6
Net cash provided by discontinued operations				—			0.6
Effect of exchange rates on cash				1.1			1.9
Net increase (decrease) in cash and cash equivalents				130.2			(2.7		)
Cash, including cash equivalents at beginning of period				47.1			48.8
Cash, including cash equivalents at end of period				$	177.3		$	46.1

 

See accompanying notes to condensed consolidated financial statements.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 1: Summary of Significant Accounting Policies

Basis of Presentation

The condensed consolidated financial statements included herein are unaudited and have been prepared in accordance with U.S. generally accepted accounting principles for interim financial reporting and Securities and Exchange Commission (“SEC”) regulations. In the opinion of management, these financial statements include all adjustments which are of a normal recurring nature, necessary for a fair presentation of the financial position, results of operations, cash flows and the change in shareholders’ equity for the periods presented. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted. The condensed consolidated financial statements for the three and six month periods ended June 30, 2007 should be read in conjunction with the consolidated financial statements and notes thereto of West Pharmaceutical Services, Inc. (which may be referred to as “West”, “the Company”, “we”, “us” or “our”), appearing in our 2006 Annual Report on Form 10-K.  The results of operations for any interim period are not necessarily indicative of results for the full year.

Reclassification

Resulting from the formation of a new innovation project team aimed at developing and strategically acquiring technology and products that complement our core injectable packaging and delivery systems business, we are now reporting a separate research and development line item on our income statement.  Amounts previously reported as part of selling, general and administrative expense and cost of goods sold have been reclassified to conform to current period classifications.

Income Taxes

The tax rate used for interim periods is the estimated annual effective consolidated tax rate, based on the current estimate of full year results, except that taxes related to specific events, if any, are recorded in the interim period in which they occur. In the second quarter of 2007, we recorded $2.5 million, or $0.06 per diluted share, in tax benefits resulting from the revision of certain tax planning strategies and the completion of related documentation supporting research and development credits related to prior year tax returns. In the first quarter of 2006, we recognized a $0.4 million, or $0.01 per diluted share, tax benefit in continuing operations relating to the resolution of a claim for a tax refund associated with the disposition of our former plastic molding facility in Puerto Rico and related interest income, net of tax, of $0.2 million. The impact of this tax refund was largely offset by a $0.4 million provision, or $0.01 per diluted share, recorded in the second quarter of 2006 related to tax issues within our Irish finance company.

Note 2:  Discontinued Operations

In the second quarter of 2007, we recorded a $0.5 million provision for claims resulting from the 2005 divestiture of our former drug delivery business.  Our six month results ended June 30, 2006 include $3.8 million as income from discontinued operations, related to the resolution of our claim for certain tax benefits associated with the 2001 disposition of our former contract manufacturing and packaging business. For the six month period ended June 30, 2006, operating cash flow from discontinued operations was $0.6 million, representing the partial collection of the approved tax claims.

Note 3:  Other (Income) Expense

Other (income) expense for the three and six month periods ended June 30 was as follows:

				Three Months Ended June 30,						Six Months Ended June 30,
(in millions)				2007			2006			2007			2006
Foreign exchange (gains) losses				$	(0.5	)	$	0.4		$	(0.3	)	$	0.2
Loss on sales of equipment				0.3			0.4			0.5			0.8
Gain on sale of investment				—			—			(0.4		)	—
Other				—			0.7			0.3			1.2
				$	(0.2	)	$	1.5		$	0.1		$	2.2

 

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Other (income) expense for the six month period ended June 30, 2007 includes a $0.4 million gain recorded by the Tech Group segment for the sale of an investment in a tool shop located in Ireland.  Other (income) expense for the six month period ended June 30, 2006 includes a $0.3 million write-off of a discontinued software project and a $0.5 million write-off of a prepaid royalty that is not expected to be recovered against future sales of a reconstitution product.

Note 4:  Income Taxes

On January 1, 2007, we adopted Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes”, an interpretation of FASB Statement No. 109, “Accounting for Income Taxes” (“FIN 48”). This interpretation clarifies the accounting for uncertainty in income taxes recognized in financial statements. FIN 48 prescribes 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. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods and income tax disclosures. The adoption of FIN 48 resulted in the recognition of net tax assets that met the more-likely-than-not threshold of $21.6 million and is reflected as an adjustment to the opening balance of retained earnings for 2007.

As of January 1, 2007, following the adoption of FIN 48, we had approximately $12.8 million of total gross unrecognized tax benefits, which, if recognized, would favorably impact the effective income tax rate. During the second quarter of 2007, our liability for unrecognized tax benefits increased by $0.6 million, as a result of tax positions taken during the current period.  The Company anticipates that the amount of unrecognized tax benefits may change in the next 12 months; however, due to uncertainties in timing, it is not reasonably possible to estimate a range of the possible change.

Interest costs and penalties related to income taxes are classified as interest expense and other expense, respectively, in the Company’s financial statements.  As of the adoption date, we had accrued interest of $0.6 million, which did not materially change during the six months ended June 30, 2007.

Because we are a global organization, we and our subsidiaries file income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions.  As of January 1 and June 30, 2007, we were subject to examination in the U.S. federal tax jurisdiction for the 2003-2006 tax years. We were also subject to examination in various state and foreign jurisdictions for the 2000-2006 tax years.

Note 5:  Comprehensive Income

Comprehensive income for the three and six month periods ended June 30 was as follows:

				Three Months Ended June 30,						Six Months Ended June 30,
(in millions)				2007			2006			2007			2006
Net income				$	26.0		$	20.7		$	52.5		$	38.8
Other comprehensive income, net of tax
Foreign currency translation adjustments				4.8			5.7			5.1			8.7
Pension and postretirement liability adjustments				0.1			(0.3		)	0.3			(0.3		)
Unrealized gains on derivatives				1.1			1.0			0.9			2.2
Other comprehensive income, net of tax				6.0			6.4			6.3			10.6
Comprehensive income				$	32.0		$	27.1		$	58.8		$	49.4

 

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Note 6:  Convertible Debentures

On March 14, 2007, the Company issued $150.0 million of Convertible Junior Subordinated Debentures (“debentures”) due March 15, 2047. On April 3, 2007, the underwriters exercised an over-allotment option resulting in the issuance of an additional $11.5 million of debentures, bringing the total aggregate principal amount outstanding to $161.5 million. The debentures bear interest at a rate of 4% annually which is payable on March 15 and September 15 of each year. The debentures are unsecured obligations and rank junior to all of our existing and future senior debt and are structurally subordinated to all indebtedness and other obligations of our subsidiaries.

The debentures are convertible into shares of the Company’s common stock at an initial conversion rate, subject to adjustment, of 17.8336 shares per $1,000 of principal amount, which equals a conversion price of approximately $56.07 per share. The holders may convert their debentures at any time prior to maturity. On or after March 20, 2012, if our common stock closing price exceeds 150% of the then prevailing conversion price for at least 20 trading days during any 30 consecutive trading day period, we have the option to cause the debentures to be automatically converted into West shares at the prevailing conversion rate. As of June 30, 2007, no debentures were converted. Accrued interest payable at June 30, 2007 was $1.9 million and is recorded in accrued expenses.

Total net proceeds from the offering were $156.4 million. We expect to use the proceeds for general corporate purposes, which may include capital expenditures, working capital, possible acquisitions of other businesses, technologies or products, repaying debt, and potentially repurchasing our capital stock. In connection with the offering, the Company incurred debt issuance costs in the amount of $5.1 million, consisting of underwriting discounts and commissions, legal and other professional fees. These costs are recorded as a noncurrent asset and are being amortized as additional interest expense over the term of the debentures.

Note 7:  Net Income Per Share

The following table reconciles net income and shares used in the calculation of basic net income per share to those used for diluted net income per share.

				Three Months Ended June 30,						Six Months Ended June 30,
(in millions, except per share data)				2007			2006			2007			2006
Income from continuing operations				$	26.5		$	20.7		$	53.0		$	35.0
Discontinued operations, net of tax				(0.5		)	—			(0.5		)	3.8
Net income, as reported, for basic net income per share				26.0			20.7			52.5			38.8
Plus: interest expense on convertible debt, net of tax				1.1			—			1.3			—
Net income, for diluted net income per share				$	27.1		$	20.7		$	53.8		$	38.8
Weighted average common shares outstanding for basic net income per share				32.9			32.1			32.8			31.9
Assumed stock options exercised and awards vested, based on the treasury stock method				1.3			1.5			1.3			1.5
Assumed conversion of convertible debt, based on the if-converted method				2.9			—			1.7			—
Weighted average shares outstanding for diluted net income per share				37.1			33.6			35.8			33.4

 

Options to purchase 0.3 million shares of common stock were excluded from the computation of diluted earnings per share for both the three and six month periods ended June 30, 2007, as their impact would be antidilutive. There were 0.3 million and 0.2 million antidilutive options outstanding during the three and six month periods ended June 30, 2006, respectively.

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Note 8:  Segment Information

Net sales and operating profit by reporting segment were as follows:

 

In February 2007, our Pharmaceutical Systems segment acquired a patent, and related assets, for total cash consideration of $4.2 million. The estimated fair value of the patent is $3.9 million and the remaining $0.3 million represents property, plant and equipment. The patent is being amortized over its remaining useful life, which was determined to be approximately 14 years.

Note 9:  Inventories

Inventories are stated at the lower of cost or market. Cost is determined using the first-in-first-out (“FIFO”) method. Inventory balances are as follows:

 

Note 10:  Stock-Based Compensation

In the first quarter of 2007, we granted 331,642 stock options at a weighted average exercise price of $44.96 per share to key employees under the 2004 Stock-Based Compensation Plan (the “2004 Plan”). The exercise price represents the grant date fair value of our stock. Stock options granted to employees vest in equal annual increments over 4 years of continuous service. All awards expire ten years from the date of grant. The weighted average grant date fair value of options granted during the first quarter of 2007 was $15.43 as determined by the Black-Scholes option valuation model using the following weighted average assumptions: a risk-free interest rate of 6.25%; expected life of 5 years; stock volatility based on history of 30.3%; and a dividend yield of 1.2%.

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We also granted 94,571 performance vesting share (“PVS”) rights at a weighted average grant date fair value of $44.96 to key employees under the 2004 Plan in the first quarter of 2007.  Each PVS right entitles the holder to one share of Company stock if annual growth rate of revenue and return on invested capital (“ROIC”) targets are achieved over a three-year period. PVS rights are granted at target levels assuming 100% achievement of the revenue-growth and ROIC goals over the performance period. The actual number of shares issued may vary from 0% to 200% of an employee’s target level.  The fair value of PVS rights is based on the market price of the Company’s stock at the grant date and is recognized as an expense over the performance period.

On May 1, 2007, the 2007 Omnibus Incentive Compensation Plan (the “2007 Plan”) was approved by the Company’s shareholders. All remaining shares under the 2004 Plan were extinguished upon adoption of the 2007 Plan. Awards granted under the 2004 Plan remain outstanding under that plan until settled. The 2007 Plan provides for the granting of stock options, stock appreciation rights, restricted stock, stock units, and performance awards to employees and non-employee directors. A committee of the Board of Directors determines the terms and conditions of awards to be granted. Vesting requirements vary by award.

At inception, there were 4,100,000 shares of common stock available for issuance under the 2007 Plan. Stock options and stock appreciation rights reduce the number of shares available by one share for each share granted. All other awards under the 2007 Plan will reduce the total number of shares available for grant by an amount equal to 2.5 times the number of shares awarded.  If any awards made under the 2004 Plan would entitle a plan participant to an amount of Company stock in excess of the target amount, the additional shares (up to a maximum threshold amount) will be distributed under the 2007 Plan.

In the second quarter of 2007, there were 18,900 deferred stock units granted to non-employee directors under the 2007 Plan.  As of June 30, 2007, there were approximately 4,048,555 shares remaining in the 2007 Plan for future grants.

Note 11:  Benefit Plans

The components of net pension expense for the three month period ended June 30 are as follows:

 

 

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The components of net pension expense for the six month period ended June 30 are as follows:

 

 

Note 12:  Commitments and Contingent Liabilities

We have accrued the estimated cost of environmental compliance expenses related to soil or ground water contamination at current and former manufacturing facilities.  We believe the accrued liability of $1.0 million at June 30, 2007 is sufficient to cover the future costs of these remedial actions.

Note 13:  New Accounting Standards

In February 2007, the FASB issued Statement of Financial Accounting Standard No. 159, “The Fair Value Option for Financial Assets and Liabilities Including an amendment of FASB Statement No. 115” (“SFAS No. 159”). This standard permits an entity to elect fair value as the initial and subsequent measurement attribute for many financial assets and liabilities. Entities electing the fair value option are required to distinguish, on the face of the statement of financial position, the fair value of assets and liabilities for which the fair value option has been elected and similar assets and liabilities measured using another measurement attribute. The adjustment to reflect the difference between the fair value and the carrying amount would be accounted for as a cumulative-effect adjustment to retained earnings as of the date of the initial adoption. This standard is effective for fiscal years beginning after November 15, 2007. Management does not believe that the adoption of SFAS No. 159 will have a material impact on our financial statements.

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ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Management’s discussion and analysis should be read in conjunction with the condensed consolidated financial statements and accompanying notes.

COMPANY OVERVIEW

We are a global pharmaceutical technology company that applies proprietary materials science, formulation research and manufacturing innovation to the quality, therapeutic value, development speed and rapid market availability of pharmaceuticals, biologics, vaccines and consumer products. We have manufacturing locations in North and South America, Europe and Asia, with affiliates in Mexico and Japan. Our business is conducted through two segments: “Pharmaceutical Systems” and “Tech Group”. Our Pharmaceutical Systems segment focuses on primary packaging components and systems for injectable drug delivery, including stoppers and seals for vials, and closures and disposable components used in syringe, intravenous (“IV”) and blood collection systems. The Tech Group operating segment offers custom contract manufacturing solutions utilizing plastic injection molding processes targeted to healthcare and consumer industries. Our global customer base includes the world’s leading manufacturers of pharmaceuticals, biologics and medical devices.

The long-term business drivers for our Pharmaceutical Systems segment’s products remain strong as we continue to see developments such as new vaccines and biologic therapeutics which require advanced packaging systems and are commonly delivered by injection. Consistent with our experience in recent years, our sales and operating results for the Pharmaceutical Systems segment in the first six months of 2007 were very strong across all product offerings. In the second half of 2007, we expect sales growth to moderate due to a combination of issues including the impact of regulatory delays and anticipated demand shifts for our customers’ product offerings and related inventory management programs. We are also in the process of renegotiating several key multi-year customer supply contracts, which we anticipate finalizing by the end of the year. The outcome of these negotiations could also affect future operating results. We remain committed to expanding our manufacturing capacity and geographic scope of our operations. Our production facilities in Europe are operating at or near full capacity and we have initiated plant expansion programs at the majority of our existing European and Asian plants designed to meet our customers’ increasing demand for our products. We also continue to move forward with our plans to establish two manufacturing facilities in China, with the timing of these projects dependent on obtaining land use and other regulatory approvals from local authorities.

Our Tech Group segment continues to support the U.S. launch of Pfizer’s Exubera® Inhalation Powder, a pulmonary insulin product developed by our customer Nektar Therapeutics. We are one of two contract manufacturers for the inhalation delivery device used with Exubera®. The initial acceptance of Exubera® by health care providers and insurers has been slower than Pfizer anticipated, and as a result their inventories have increased. While we are committed to fulfilling current orders, we expect Pfizer’s high inventory levels and slower-than-expected demand will affect our fourth quarter 2007 and full-year 2008 sales levels. We had anticipated the reduction in Exubera® activity and included the estimated impact in our 2007 earnings projections. In coordination with our customer, Nektar, we have reduced production to one shift per day at our dedicated facility beginning in the third quarter of 2007. The costs for any associated severances will be reimbursed to us by Nektar. Pfizer has initiated new physician education and direct-to-consumer marketing programs and continues to promote Exubera®. Another key objective for our Tech Group in the second half of 2007 is to complete customer acceptance procedures at our new facility in Michigan, and to begin to benefit from the additional medical device component production capacity available at this site. Incremental costs resulting from the relocation of equipment to the new facility and start-up costs incurred in connection with initial production should decline in the second half of 2007.

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We continue to pursue innovative drug delivery platforms and are actively developing an array of potential product offerings. While there is no guarantee these efforts will be successful, our initial research, regulatory review and prototype development work have met our expectations. We plan to increase spending on product development with an emphasis on commercializing our innovation programs. Consistent with this emphasis on innovation, we are now reporting a separate research and development line item on our income statement. Amounts previously reported as part of selling, general and administrative expense and cost of goods sold have been reclassified to conform to current period classifications.

NET SALES

The following table summarizes net sales by reportable segment:

 

Consolidated 2007 second quarter net sales increased by $23.5 million, or 9.8%, over those achieved in the second quarter of 2006. Foreign currency translation accounted for $9.1 million, or 3.8 percentage points, of the sales growth. Excluding foreign currency translation, consolidated 2007 second quarter net sales increased $14.4 million or 6.0% over the prior year quarter.

In the Pharmaceutical Systems segment, second quarter 2007 net sales were $22.9 million, or 13.8%, favorable to those achieved in the prior year quarter. Foreign currency translation accounted for $8.4 million, or 5.1 percentage points, of the increase. Excluding foreign currency translation, second quarter 2007 net sales in the Pharmaceutical Systems segment were $14.5 million, or 8.7%, above those achieved in the second quarter of 2006. Price increases accounted for approximately 2.8 percentage points of the quarter-to-quarter sales increase. Unit volumes increased approximately 5% over the prior year quarter. Our second quarter sales increases were strongest in Europe, led by sales of Westar® Ready-to-Sterilize processed Flurotec® coated plungers used in pre-filled syringe systems for various biotech customers’ products. Total sales of pre-filled syringe components represented $7.0 million of our 2007 second quarter sales increase. Sales of serum stoppers were strong in all geographic markets, up 13%, or $4.7 million, over second-quarter 2006 levels. Sales of our reconstitution systems, IV stoppers and Flip-off® seals were also higher than in the prior year period.

In our Tech Group segment, 2007 second quarter net sales were $1.2 million, or 1.5% above those reported in the prior year. Foreign currency translation accounted for $0.7 million, or 0.8 percentage points, of the increase. Excluding foreign currency translation, second quarter 2007 net sales in the Tech Group segment were $0.5 million, or 0.7 %, above those achieved in the second quarter of 2006. Price increases accounted for 0.5 percentage points of the quarter-to-quarter sales increase. Sales growth in the Tech Group segment was constrained by a $6.2 million decrease in revenue from low-margin tooling projects. Net sales of the Exubera ® inhalation device were $1.5 million higher than in the 2006 second quarter, largely benefiting from Pfizer’s inventory requirements in connection with the launch of the product in the United States. The Tech Group segment also generated a $3.8 million sales increase related to packaging for a weight loss drug, which our customer launched in June of 2007. Other Tech Group segment sales netted to a $1.4 million increase, led by increased sales of a device used in cardiac surgery.

Consolidated net sales for the six months ended June 30, 2007 increased by $58.3 million, or 12.6%, compared to the first six months of 2006. Foreign currency translation accounted for $19.6 million, or 4.2 percentage points, of the sales growth. Excluding foreign currency translation, consolidated 2007 year-to-date net sales increased $38.7 million, or 8.4%, over the prior year.

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The Pharmaceutical Systems segment contributed $54.3 million of the year-to-date net sales increase, including $18.1 million resulting from favorable foreign currency translation. Excluding foreign currency translation, Pharmaceutical Systems net sales were $36.2 million, or 11.1%, above prior year levels. Sales price increases contributed approximately 2.5 percentage points of the year-to-date net sales increase over the prior year. The Pharmaceutical Systems sales growth was strong in all geographical regions; with sales in our North American region almost 13% above those achieved in the six-month period ended June 30, 2006. The U.S. sales were driven by strong demand for serum stoppers used in vial packaging for vaccines, injectable treatments for chronic diseases, and packaging for biotechnology company products. Sales in our European operations, excluding the effects of foreign exchange rates, were almost 10% above those recorded in the first half of 2006, led by increased demand for pre-filled injection system components.

Tech Group segment year-to-date net sales were $4.5 million above prior year levels, $1.5 million of which resulted from foreign currency translation. Price increases contributed approximately one percentage point of the sales increase in the Tech Group segment. Tech Group sales benefited by an $8.0 million increase in sales to Nektar of the Exubera® device due to timing of the product launch, and an $8.6 million increase in other plastic packaging components used in the packaging of a weight loss product and in an over-the-counter cold remedy. Tech Group sales growth was constrained however by an $11.4 million decline in revenue from tooling and design projects, and a $2.2 million sales decrease in consumer products.

GROSS PROFIT

The following table summarizes our gross profit and related gross margins by reportable segment:

Gross profit:				Three Months Ended						Six Months Ended
				June 30,						June 30,
($ in millions)				2007			2006			2007			2006
Pharmaceutical Systems Segment
Gross Profit				$	67.0		$	60.6		$	138.9		$	118.0
Gross Margin				35.4		%	36.4		%	36.5		%	36.1		%
Tech Group Segment
Gross Profit				$	9.7		$	10.5		$	18.2		$	20.8
Gross Margin				12.5		%	13.8		%	12.4		%	14.7		%
Consolidated gross profit				$	76.7		$	71.1		$	157.1		$	138.8
Consolidated gross margin				29.1		%	29.6		%	30.1		%	30.0		%

 

Second quarter 2007 consolidated gross profit improved to $76.7 million, a $5.6 million increase over the 2006 second quarter consisting of a $6.4 million increase in Pharmaceutical Systems segment gross profit, partially offset by a $0.8 million decline in Tech Group segment gross profit.

In the Pharmaceutical Systems segment, our second quarter 2007 gross margin declined by 1.0 percentage point from that achieved in the 2006 second quarter. The majority of the decline in our margins occurred in Europe, where incremental overtime and other production inefficiencies resulting from the volume constraints placed on our existing capacity more than offset favorable product mix impacts. An inventory write-off related to damaged finished product in Germany also contributed to the decrease in gross margin. Sales price increases were offset by higher direct labor, material and other plant overhead costs, including severance provisions at our facility in the United Kingdom connected to the loss of a low margin product line.

In the Tech Group segment, gross margins declined by 1.3 percentage points in the comparison of second quarter 2007 results to 2006. The incremental costs associated with the relocation, validation and start-up of our new facility in Michigan resulted in a $1.2 million loss at this facility, accounting for 1.5 percentage points of our decline in gross margin. Higher utility expenses, labor costs and unfavorable efficiency variances resulted in an additional 1.0 percentage point margin reduction, offset by volume and mix variances, which were 1.2 percentage points favorable, despite the impact of lower tooling revenues.

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For the six month period ended June 30, 2007, gross profit was $18.3 million above that reported in the 2006 six month period with consolidated gross margins roughly even with prior year levels. The Pharmaceutical Systems segment contributed $20.9 million of the gross profit increase and improved gross margins by 0.4 percentage points over the prior year period. Overall price increases in the Pharmaceutical Systems segment exceeded related material and direct labor cost increases, contributing 0.5 percentage points to segment gross margin. The impact on gross margin of favorable product mix variances was more than offset by increased plant overhead costs, including quality control, supplies and maintenance expenses in large part associated with the European plant expansions, and overtime and production inefficiencies associated with our volume constrained European plants. Tech Group segment gross profit declined $2.6 million from that achieved in the first half of 2006, principally due to a $2.7 million gross profit decrease at our facilities in Michigan due to incremental costs, overhead and production inefficiencies related to our relocation to a new, larger facility. We expect these relocation costs and related inefficiencies to decline as the new facility comes on-line during the third quarter of 2007. The combined impact of higher overheads principally related to the Michigan relocation and lower utilization of our tooling capacity reduced the Tech Group Segment’s year-to-date 2007 gross margin by approximately three percentage points.

RESEARCH AND DEVELOPMENT (“R&D”) COSTS

Research and development (R&D):				Three Months Ended						Six Months Ended
				June 30,						June 30,
($ in millions)				2007			2006			2007			2006
Pharmaceutical Systems segment				$	3.3		$	2.0		$	6.3		$	3.8
Tech Group segment				0.5			0.6			1.1			1.3
Total R&D expense				$	3.8		$	2.6		$	7.4		$	5.1

 

At the end of 2006, we created an innovation group responsible for seeking new opportunities in injectable packaging and delivery systems and for transitioning our Tech Group segment from primarily a contract manufacturer to a producer of high-value proprietary systems and products. The majority of the increase in 2007 R&D costs reflects the formation of this new team, whose efforts augment those of our previously existing engineering and laboratory personnel. We now expect to spend approximately $17 million in total R&D costs during 2007, as compared to full year 2006 R&D costs of $11.1 million.

SELLING, GENERAL AND ADMINISTRATIVE (“SG&A”) COSTS

The following table summarizes SG&A costs by reportable segment including corporate and unallocated costs: 

Selling, general and administrative costs (SG&A):				Three Months Ended						Six Months Ended
				June 30,						June 30,
($ in millions)				2007			2006			2007			2006
Pharmaceutical Systems SG&A costs				$	24.1		$	19.4		$	47.7		$	38.5
Pharmaceutical Systems SG&A as a % of segment net sales				12.7		%	11.7		%	12.5		%	11.8		%
Tech Group SG&A costs				$	5.7		$	4.9		$	11.1		$	9.6
Tech Group SG&A as a % of segment net sales				7.3		%	6.4		%	7.6		%	6.8		%
Corporate costs:
General corporate costs				4.9			5.6			10.9			11.6
Stock-based compensation expense				1.9			2.7			2.3			6.9
U.S. pension plan expense				1.6			2.3			3.2			4.6
Total Selling, General & Administrative costs				$	38.2		$	34.9		$	75.2		$	71.2
Total SG&A as a % of total net sales				14.5		%	14.5		%	14.4		%	15.4		%

 

Consolidated SG&A expenses for the three and six month periods ended June 30, 2007 were $3.3 million and $4.0 million, respectively, above those recorded in the corresponding periods of 2006. Foreign exchange translation accounted for $1.0 million and $2.1 million of the increase in the three and six month period comparisons, respectively.

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In the Pharmaceutical Systems segment, second quarter 2007 SG&A expenses increased by $4.7 million over the prior year second quarter. Approximately $1.8 million of the increase was compensation related including higher incentive compensation costs particularly in Europe, increased staffing of sales, strategic marketing and information systems functions, and the impact of annual salary increases. Professional services costs were $1.3 million higher than in the prior year quarter reflecting higher sales commission charges and consulting costs involved with the implementation of various information systems in the United States. Foreign currency translation accounted for $1.0 million of the SG&A increase. Other cost increases totaling $0.6 million consisted mostly of higher sales training, depreciation and insurance charges.

For the six month period ended June 30, 2007, Pharmaceutical Systems segment SG&A costs were $9.2 million higher than the prior year period. Employee compensation costs contributed $3.9 million of the increase, with professional service costs ($2.2 million), foreign currency translation ($2.0 million) and other costs ($1.1 million) accounting for the remaining increase over first half 2006 levels, for the same factors as discussed above.

Second quarter 2007 SG&A costs in the Tech Group segment were $0.8 million above the prior year second quarter. Approximately one-third of the increase is due to higher sales commissions, one-third due primarily to prior year recoveries on uncollectible accounts receivable provisions, with the remaining increase associated with increased staffing of human resource, purchasing and quality control functions. For the six month period ended June 30, 2007, Tech Group segment SG&A costs were $1.5 million above 2006 with approximately $0.8 million of the increase attributed to the increased staffing levels, with sales commissions and prior year bad debt recoveries accounting for the majority of the remaining year-to-date increase.

General corporate SG&A costs include executive compensation and other costs, Board of Directors compensation, legal, compliance, finance and communication expenses. These costs were $0.7 million below those incurred in the prior year quarter and six month period, primarily due to lower incentive compensation costs.

Stock-based compensation costs for the second quarter of 2007 decreased by $0.8 million from the 2006 second quarter, due to lower deferred compensation plan expense and a decrease in West stock-price indexed compensation costs. West’s stock price increased $0.72 per share during the second quarter of 2007 as compared to an increase of $1.56 per share during the second quarter of 2006. In the comparison of our first half 2007 results to 2006, stock compensation costs declined by $4.6 million. Our stock price decreased $4.08 per share during the first six months of 2007, closing at $47.15 per share on June 30, 2007. In the first half of 2006, our stock price increased $11.25 per share closing at $36.28 per share at June 30, 2006. Our deferred stock plans held approximately 300,000 stock equivalent units during comparative 2007 and 2006 periods. The resulting change in the fair value of our stock equivalent unit liabilities accounts for almost all of the $4.6 million decrease in the comparison of first half 2007 and 2006 stock-based compensation costs.

U.S. pension plan expenses in 2007 were $0.7 million and $1.4 million lower than the corresponding second quarter and six month period of 2006. The decrease largely results from a 2006 amendment to our qualified defined benefit pension plan in the United States. Under the amended plan, benefits earned under the plan’s pension formulas and accruals for both hourly and salaried participants were frozen as of December 31, 2006 and replaced with new cash-balance formulas resulting in a reduction of our projected benefit obligation.

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