West third quarter gross profit increases $3.0 million to $74.7 million

West Pharmaceutical Services, Inc. (NYSE: WST) today announced its financial results for the third quarter of 2010.  

Summary comparative results were as follows:

Sales increased 4.8% in the third quarter compared to the 2009 quarter, overcoming the adverse comparative effects of both $10.0 million of foreign currency translation and $9.7 million of non-recurring H1N1 flu vaccine-related sales during the 2009 period. Excluding currency translation, sales increased by $22.5 million, or 8.7%, compared to the third quarter of 2009.  Both of the Company's business segments generated sales growth compared to the prior year, with increased sales of proprietary products contributing to growth in each segment.  

Gross profit grew by $3.0 million, to $74.7 million from the third quarter of 2009, despite the $2.4 million adverse impact of foreign currency translation. Gross profit margin declined 0.2 percentage points, to 27.5% in the current quarter, as increased sales of higher margin products partially mitigated the effects of relatively higher operating costs.

A decline in SG&A costs as a percentage of sales was attributed primarily to decreases in U.S. pension and stock-based compensation costs, which more than offset the adverse effects of the lower consolidated gross margin and increased R&D spending in Pharmaceutical Delivery Systems.  As a result, Adjusted Operating Profit was $1.7 million, or 7.7%, higher than in the prior-year period and was 8.7% of sales, a 0.2 percentage point improvement from the 2009 quarter.  

Executive Commentary

"The third quarter is generally our most challenging, and I am very pleased to report results that are ahead of last year's atypically strong third quarter results," said Donald E. Morel Jr., PhD, the Company's Chairman and Chief Executive Officer. "These results reflect the fundamental strength and stability of our business, and the value and staying power of product innovations that West and its partners have brought to market. Our Westar® RS and FluroTec® products have been  engines of growth for several years and are continuing to gain sales and market share. We firmly believe that our newer products, including packaging component technologies like Westar® RU and Envision™, as well as Daikyo Crystal Zenith® containers and prefillable syringes, embody the same combination of customer-focused innovation and product quality that will generate similarly sustainable and profitable growth for many years."

"For the remainder of 2010, we expect to close much of the sales gap created by the non-recurrence of last year's H1N1 sales and the adverse effects of the stronger dollar are diminishing. We now anticipate full-year 2010 adjusted earnings per share to be between $2.13 and $2.20."

"Looking ahead to 2011 and excluding currency effects, we expect sales growth in the range of 3% to 5%, based primarily on anticipated growth in the underlying pharmaceutical markets we serve, including more rapid growth in the world's developing markets, particularly in Asia.  We expect revenue to grow somewhat faster than unit growth in those underlying markets as a result of growing sales of our higher-value pharmaceutical packaging components and proprietary delivery systems. We also expect to increase our related R&D efforts in order to accelerate our revenue growth beyond 2011."  

Pharmaceutical Packaging Systems

Third-quarter Pharmaceutical Packaging Systems sales of $191.5 million were slightly higher than the $189.9 million reported in third quarter of 2009, achieving that increase despite the adverse comparative effects of both $9.7 million of non-recurring H1N1 vaccine-related sales recorded in the 2009 period, and $8.0 million of unfavorable foreign currency translation.  Excluding currency effects, sales grew 5.1% over the prior-year period.  Sustained growth in the Company's advanced pharmaceutical packaging product lines overcame the H1N1-related sales decline, and included increases in sales of Westar-processed and FluroTec-coated products, as well as Envision-inspected products that were introduced in 2009.

Sales grew in all geographic regions compared to the 2009 period excluding currency effects. European sales were 6.0% higher excluding currency effects, while North American sales were approximately 5.0% higher. The combined sales in the Company's smaller Asian and South American businesses continue to generate faster growth, increasing by approximately 25% (18% excluding currency).    

Gross profit was $58.5 million in the quarter, down from $59.2 million in the prior-year period.  Growth in sales, including modest price increases over the prior year, were outpaced by $2.0 million of adverse foreign currency translation effects and increased production costs, including raw materials. As a result, gross margin declined by 0.7 percentage points, to 30.5% in the quarter.

R&D costs of $2.3 million were slightly lower than in the prior-year period, primarily as a result of currency translation.  SG&A costs of $26.6 million were $0.9 million higher than in the prior-year quarter, net of $0.8 million of currency translation, primarily for employee compensation that included approximately $0.5 million of severance costs.  As a result, operating profit of $29.4 million was $1.5 million lower than in the third quarter of 2009, with $1.1 million of the decline attributed to currency translation, and the segment's operating margin was 15.4%, or 0.9 percentage points lower.  

Pharmaceutical Delivery Systems

Pharmaceutical Delivery Systems sales were $81.0 million in the quarter, a $10.8 million, or 15.4%, increase over the third quarter of 2009, net of $2.0 million, or 2.8 percentage points, of unfavorable currency translation.  Approximately $0.7 million of the increase was attributed to a business acquired in 2010.  $6.7 million of the sales increase was due to growth in contract manufacturing for customers in the healthcare and personal care product markets, including related development services and the pass-through of higher resin costs.  Proprietary product sales contributed $3.6 million of the increase. Approximately 80% of segment revenues are from contract manufacturing, while 20% are from proprietary products, substantially unchanged from the immediately preceding quarter.  Proprietary products include drug reconstitution aids, Eris^™ safety syringes, and Daikyo Crystal Zenith packaging and prefillable syringes.

Gross profit grew by more than 30% to $16.2 million and gross profit margin improved by 2.3 percentage points to 20.0% from the third quarter of 2009. Foreign currency translation reduced gross profit by $0.4 million.  The increases in gross profit and margin were driven by increased volumes of both contract manufactured and proprietary products and increased development service revenues.

Research and development costs grew $0.9 million on increased development activity relating to proprietary products.  SG&A costs were also $0.9 million higher than in the third quarter of 2009 on higher sales commissions associated with volume increases and new product support and increased organizational costs associated with the January 2010 business segment realignment.  Operating profit was $3.6 million, a $2.0 million increase over the prior-year period.

Corporate and Other

U.S. pension expense decreased by $1.3 million, to $3.0 million, in the third quarter compared to the same period last year and is primarily the effect of increased pension-plan asset balances, net of increased present values of pension obligations, at the prior year end.  This is consistent with earlier 2010 quarters and included an additional   benefit in the quarter to reconcile with the final actuarial measurements for this year.

Stock-based compensation expense decreased $1.4 million compared to the prior-year quarter, primarily the result of changes in the Company's share price, which declined during the current quarter and which had risen during the same period last year. Other unallocated corporate, general and administrative costs were $1.5 million higher in the quarter due to increased performance-based compensation costs for 2010 and higher external consulting service costs.

Net interest expense of $4.1 million was $0.6 million higher in the 2010 quarter primarily as a result of lower capitalization of interest. Excluding items described in "Restructuring and Other Items", the quarterly effective tax rate was 25.0% in the current period, compared to 22.3% in the prior-year period.  The expected annual effective tax rate for 2010 now stands at 24.2%, compared to 23.4% for 2009, in both cases excluding the effects of discrete items. The year-over-year increase in the expected annual effective tax rate is due primarily to the December 2009 expiration of the U.S. tax credit for certain research activities.

Net income includes $1.1 million of equity in earnings of affiliated companies in which the Company owns a minority interest, a $0.3 million increase over the prior year that was primarily the result of improved operating results in Daikyo Seiko, Ltd., the Company's 25% owned affiliate based in Japan.

Restructuring and Other Items

In the fourth quarter of 2009, West announced a restructuring plan for certain U.S. businesses.  During the third quarter of 2010, $0.2 million of related restructuring costs were incurred, and a total of $1.2 million of related charges have been incurred in the nine months ended September 30, 2010. The Company expects to conclude the restructuring during 2010.

During the current quarter, the Company recorded a $1.8 million pre-tax benefit associated with its reassessment of contingent consideration obligations associated with the July 2009 acquisition of certain business assets and intellectual property, including the Eris safety syringe. The benefit reflects a reduction in the fair value of the contingent obligation as of September 30, 2010.

During the current quarter, the Company recorded a net tax benefit of $0.5 million associated with several discrete tax items, primarily the resolution of tax contingencies relating to other periods.  During the third quarter of 2009, the Company recorded a $3.9 million pre-tax ($1.7 million after-tax) benefit associated with a tax amnesty program in Brazil, and an additional $0.4 million in other discrete tax benefits.

Financial Guidance

The Company provided its initial estimates of revenue growth for calendar year 2011 and updated certain financial guidance for calendar year 2010.

The Company's updated revenue and earnings expectations for calendar year 2010 are summarized as follows:

Changes to its prior guidance include an approximately $0.03 per diluted share improvement as a result of a reduction in the Company's estimate of the adverse effects of foreign exchange on full-year operating results. The balance of the changes reflect the Company's third-quarter performance and outlook for its businesses in the fourth quarter, including among other things the expected development of sales and product mix in the fourth quarter of 2010.

The Company continues to expect that comparisons of results for the fourth quarter of 2010 to the corresponding 2009 period will be less favorable than in the first nine months of 2010. Atypical seasonality in the Company's sales during 2009 resulted in unusually strong results in the second half of that year compared to prior years. That effect was associated with a general improvement in the business environment, but was more pronounced as a result of the benefits of substantial non-recurring 2009 sales associated with the H1N1 pandemic preparedness effort, which contributed approximately $0.09 per diluted share in the fourth quarter of 2009, and of a relatively weak U.S. dollar.  At assumed exchange rates, currency will have an adverse impact of approximately $0.03 per share in the fourth quarter of 2010 compared to the 2009 period.

The Company now expects that full-year 2010 capital spending will be between $80 million and $90 million.

The Company expects consolidated 2011 sales revenue to grow 3% to 5% from the expected 2010 revenue at constant exchange rates. The Company will provide further 2011 guidance when it announces results for the fourth quarter and full year 2010, in February 2011.