FINANCIAL REVIEW
COMPANY OVERVIEW
West Pharmaceutical Services, Inc. (the Company) provides systems and device
components, primarily for parenterally administered drugs, and develops
proprietary drug formulation and delivery technology for nasal and targeted oral
delivery of pharmaceutical products. These distinct but complementary businesses
are organized into two reportable segments: Pharmaceutical Systems and Drug
Delivery Systems. West serves a customer base consisting of virtually every
major pharmaceutical manufacturer, as well as many generic drug manufacturers,
biotechnology companies and medical device firms. The Company has manufacturing
locations in North and South America, Europe and Singapore, with partners in
Mexico and Japan.
The Pharmaceutical Systems segment develops, manufactures and sells
components and systems for injectable, transmucosal, oral and pulmonary drug
delivery, including those used for parenteral drug delivery. The closure systems
include elastomeric stoppers, which come into direct contact with drug compounds
and therefore are subject to demanding regulatory requirements, and aluminum
seals sold with and without plastic buttons. The aluminum seals and plastic
button components are sold in various sizes, shapes and colors to provide
customers with product differentiation and anticounterfeiting features. The
segment also manufactures elastomer components for blood collection systems,
intravenous drug delivery systems, and empty and pre-filled syringes. Other
products in this segment are manufactured from plastics, including
child-resistant and tamper-evident closures; dispensers for personal care
products, such as unique toothpaste dispensers; and components used to seal
beverage containers.
The Pharmaceutical Systems segment has three business units: the Americas,
Europe/Asia and the Device Group. The Americas and Europe/Asia business units
manufacture and sell the majority of the Company's elastomer and metal component
products in their respective geographic regions. The Device Group, formed during
2003, provides added focus to the development and sale of next-generation
product delivery systems relying heavily on plastic injection molding and
assembly, within the pharmaceutical, diagnostic and consumer markets. The group
is focused on opportunities requiring product design, clean room molding,
high-speed assembly and regulatory compliance.
The Pharmaceutical Systems segment operates in a global market growing
annually at a rate of approximately 3% to 5% in unit volume. The Company has
achieved growth above this level by introducing value-added enhancements such as
advanced coating technologies (FluroTec and B2-Coating) and post-manufacturing
processes (Westar) for washing, siliconizing and preparing components for
customer sterilization processes. Because the Westar process eliminates time and
capital-intense operations from a customer's manufacturing process, the Westar
product line has experienced steady growth. The Company is currently adding
Westar capability to Company facilities in Germany, France and Singapore and
expanding capacity in the United States. The global availability of Westar
enables customers to manufacture products outside of the United States using
West closures that consistently meet the rigorous requirements of the U.S. Food
and Drug Administration guidelines.
Management believes that revenues in the Pharmaceutical Systems segment will
grow at a rate slightly above that of the overall market, as it anticipates
continued strong customer demand for high-value barrier coatings and Westar
processed components, offset partially by industry trends such as pricing
pressures, inventory management and mergers and acquisitions. Some of our
pharmaceutical company customers are facing patent expirations resulting in
competition from generic manufacturers. This risk is mitigated by West's
position as a key supplier to numerous emerging generic companies. The impact of
dwindling pipelines for major pharmaceutical manufacturers is often mitigated by
new drugs purchased or in-licensed from smaller biotechnology companies. The
Company lists biotechnology companies among its fastest-growing market segments
and has developed a concerted sales and marketing effort to address biotech
needs. Advanced coating technologies and Westar processing are examples of our
products that satisfy the specific requirements of the biotechnology industry.
In the near term, management will focus on replacing the production capacity
lost in the accident at the Kinston, N.C., facility. Longer-term efforts will
focus on developing high-value processes and products for the Company's
traditional pharmaceutical industry customers and for its expanding customer
base in the biotechnology industry.
The Drug Delivery Systems segment is engaged in the development of
proprietary drug delivery systems and products for various small molecule and
biological active ingredients where alternative methods and routes of
administration (e.g., nasal) might improve the therapeutic performance, the side
effect profile and/or the cost effectiveness of the therapy. The Company's
patented technologies include nasal delivery technologies, using ChiSys
(chitosan) and pectin for the delivery of small molecular weight drugs,
proteins, peptides, and vaccines, and TARGIT, a polymer-coated starch capsule
for the specific delivery of therapeutic agents to the colon and the terminal
end of the small intestine. These efforts incorporate internal and client-funded
research to develop unique delivery technologies and products. The segment
consists of a research and development unit concentrating on the development and
commercialization
of the Company's patented technologies and products, and a clinical services
organization that conducts primarily Phase I and II clinical trials, with
capabilities available to support later phases of the drug development process.
The business strategy for this segment is focused on advancing products that use
the Company's patented drug delivery technologies through early phase clinical
trials and then out-licensing the products to pharmaceutical and other firms in
exchange for a combination of milestone fees, development cost reimbursements
and royalties. Management, combining input from current and potential licensing
partners with that from a scientific advisory board including members of leading
university, hospital and other research centers, has prioritized its portfolio
of projects in order to focus on near-term licensing opportunities.
RESULTS OF OPERATIONS
The Financial Review of the Company's operating results for the three years
ended December 31, 2003, and its financial position as of December 31, 2003,
should be read in conjunction with the accompanying consolidated financial
statements appearing elsewhere in this report.
In December 2002, the Company sold its consumer healthcare research unit. In
November of 2001, the Company sold its contract manufacturing and packaging
operations. These transactions both involved the disposal of a component of the
Company for which operations and cash flows were clearly distinguished from the
rest of the Company, and accordingly, all prior periods have been restated to
reflect the results of these businesses as discontinued operations. In addition,
certain reclassifications were made to prior period amounts in order to be
consistent with the current period reporting presentation.
NET SALES
The following table summarizes the Company's sales by product group:
($ in millions) 2003 2002 2001
- --------------------------------------------------------------------------
Pharmaceutical packaging $ 341.2 $ 286.2 $ 256.6
Disposable medical components 100.4 88.6 88.1
Personal care/food packaging 32.2 30.7 27.6
Laboratory and other services 9.6 7.3 4.1
- --------------------------------------------------------------------------
Net sales - Pharmaceutical Systems 483.4 412.8 376.4
Clinical services 5.4 5.3 7.8
Development/licensing revenue 1.9 1.6 8.1
- --------------------------------------------------------------------------
Net sales - Drug Delivery Systems 7.3 6.9 15.9
- --------------------------------------------------------------------------
Net sales - Consolidated $ 490.7 $ 419.7 $ 392.3
==========================================================================
Consolidated 2003 net sales increased 17% over sales reported in 2002.
Approximately 7% of the sales increase resulted from the strengthening of the
euro and other currencies against the U.S. dollar in foreign currency exchange
markets. Sales in the Pharmaceutical Systems segment were strong both in
international markets (25% growth over 2002, 16% of which was due to foreign
currency translation) and in domestic markets (10% growth). The success of
customer products for the treatment of diabetes and oncology, as well as various
dental applications, led to increased sales of component parts for both
prefillable injection systems (pharmaceutical packaging) and non-filled syringes
(disposable medical components) in Europe. The increased sales volumes in Europe
were made possible by plant expansions in Germany and France that started to
come on-line in the fourth quarter of 2002. Several European customers increased
in-house inventory levels during 2003, which are expected to result in stock
reduction programs and slower sales growth in 2004. In the United States, sales
of products sold under the Company's distributorship agreement with Daikyo
Seiko, Ltd. were significantly above 2002 levels, with a portion of this demand
attributed to quantities purchased for customer product qualification and
validation activities which may result in slower sales growth in 2004. Sales
growth remained strong both for Westar processed products and for traditionally
processed Teflon(R) treated serum stoppers, partially due to customer purchases
of safety stock in advance of a pending formulation change. In addition, the
successful introduction of West's D-I-D (Decoration-Identification-
Differentiation) System, used by customers to combat drug counterfeiting, led to
sales growth in the Company's Flip-Off seal product line. Overall price
increases accounted for 1.6% of the sales increase over 2002. The sales order
backlog for the Pharmaceutical Systems segment at December 31, 2003, was $131.6
million, versus $118.8 million at December 31, 2002, with all of the increase
over the prior year attributed to the strength of foreign currencies versus the
U.S. dollar.
Revenues in the Drug Delivery Systems segment were slightly higher than 2002
levels. Revenues were received for both research and development services and
the achievement of certain milestones from some of the Company's licensees. In
addition, progress was made in advancing other key product development programs,
but not to the point where significant milestone revenues were earned in 2003.
As a result of increased business development efforts, the clinical services
unit experienced a significant revenue increase in the second half of 2003,
recovering from the declines experienced during the second half of 2002 and the
first half of 2003. The backlog of studies for the clinical services unit at
December 31, 2003, was $3.8 million, more than double the amount from the prior
year end, indicating stronger sales growth in 2004.
Consolidated net sales of $419.7 million in 2002 compare with sales of
$392.3 million in 2001. Sales in the
Teflon(R) is a registered trademark of E.I. DuPont de Nemours & Company.
Pharmaceutical Systems segment increased almost 10% in 2002 versus 2001.
International sales grew by 15%, while domestic sales increased by 5%.
Consistent sales increases were experienced in all pharmaceutical packaging and
processing products, led by serum and lyophilization stoppers, and prefillable
syringe components. Sales of disposable medical components also increased, led
by increased sales of stoppers, plungers and other items used in non-filled
syringes. Price increases accounted for 1.5% of the sales increase over 2001.
Foreign exchange rates did not impact comparisons of 2002 sales to 2001, as the
dollar's decline against European currencies was largely offset by currency
devaluation in South America. 2002 revenues in the Drug Delivery Systems segment
were $9.0 million lower than 2001 results. Project delays and cancellations led
to lower licensing-related revenues from ChiSys and other technologies. In
addition, a decrease in the number of studies conducted by our customers in the
pharmaceutical outsourcing market contributed to lower sales for the clinical
services unit.
OPERATING PROFIT
The following table summarizes the Company's operating profit by reportable
segment, including corporate costs, U.S. pension plan income (expense) and other
charges recorded in consolidated operating profit for the three years ended
December 31, 2003:
($ in millions) 2003 2002 2001
- -----------------------------------------------------------------
Pharmaceutical Systems segment $ 88.2 $ 65.1 $ 55.2
Drug Delivery Systems segment (17.5) (15.0) (4.3)
Corporate costs (20.1) (17.9) (16.2)
Pension income (expense) (6.4) 2.7 8.1
Insurance settlement 17.3 -- --
Restructuring and impairment charges (7.0) (9.9) (2.9)
Foreign exchange gain -- 1.7 --
- -----------------------------------------------------------------
Consolidated operating profit $ 54.5 $ 26.7 $ 39.9
=================================================================
PHARMACEUTICAL SYSTEMS
Operating profit in the Pharmaceutical Systems segment increased by $23.1
million over 2002 results. The strength of European currencies versus the U.S.
dollar contributed $5.8 million of the profit improvement. Gross margin was
31.7%, 28.5% and 28.4% in 2003, 2002 and 2001, respectively. In addition to
providing the means to achieve higher sales volumes, the completion of the plant
expansion projects in Germany and France greatly reduced production
inefficiencies and resulted in substantially improved margins from European
operations. In the United States, production costs greatly increased following
the accident at the Kinston, N.C., rubber molding and compounding facility. Many
Kinston employees were temporarily relocated to other production facilities in
North America, and additional shifts and overtime were used to increase
production at these facilities and at plants in the United Kingdom and
Singapore. As a result of these efforts, customers did not suffer any
significant interruptions in supply. The increased production costs associated
with the manufacturing recovery plan, totaling $9.8 million, were covered by
reimbursements obtained under the Company's property and business interruption
insurance policy, resulting in gross margins in the United States comparable
with prior year levels. Selling, general and administrative costs in the
Pharmaceutical Systems segment were approximately 13% of net sales in each
period.
The Company and its principal insurer reached a settlement agreement
resulting in the final payment of all amounts due under the policy in February
2004. The settlement agreement covered all of the Company's current and
projected claims under the insurance policy. Therefore, no future business
interruption reimbursements will be received. The higher production costs,
currently estimated at approximately $10 million to $12 million for 2004, are
expected to continue until approximately September of 2004, leading to a decline
in the gross profit margin in the Pharmaceutical Systems segment. Beginning in
the fourth quarter of 2004, the Company expects production capacity to return to
historical levels as a new rubber molding facility currently under construction
in Kinston becomes fully operational.
DRUG DELIVERY SYSTEMS
Operating losses in the Drug Delivery Systems segment were $2.5 million above
those recorded in 2002. In the second half of 2002 and throughout 2003, the
Company funded research and development of a generic version of a nasally
delivered allergy product. The Company currently expects to complete a licensing
agreement for this product during the first half of 2004 that will provide the
Company with milestone and royalty revenue. Operating losses in the clinical
services unit remained about equal with 2002 results. In addition to the absence
of research costs associated with the development of the generic nasal allergy
product, 2001 results benefited from ChiSys licensing revenues associated with a
nasal morphine system and a nasal flu vaccine.
CORPORATE COSTS
Corporate administrative and other expenses increased by $2.2 million in 2003
compared to 2002. Incentive compensation costs increased, primarily due to
the achievement of increased operating results. Also contributing to the
higher corporate costs were expenses associated with implementing Sarbanes-Oxley
requirements, including the newly created position of Chief Compliance Officer
and increased staffing of the internal audit function. In addition, the
increase in the Company's stock price resulted in higher directors' compensation
plan costs. Partially offsetting these cost increases was a decrease in
information systems project expenses. Corporate costs in 2002 exceeded 2001
spending, principally due to higher executive compensation costs, increased
funding of the internal audit function and higher consulting charges for
international tax planning.
PENSION INCOME (EXPENSE)
The Company's U.S. pension plan performance declined during 2002, reflecting
the decline in the fair market value of plan assets throughout 2002 and 2001.
The decrease in asset value produced unrealized losses, which for accounting
purposes are amortized into expense over subsequent periods. During 2003, the
recovery in the U.S. stock market produced unrealized gains that will help
reduce future pension costs. The Company projects that U.S. pension plan
expenses will be slightly lower in 2004 as a result of the closing asset values
at December 31, 2003.
INSURANCE SETTLEMENT
On January 29, 2003, the Company's Kinston, N.C., plant suffered an explosion
and related fire that resulted in six deaths, a number of injured personnel and
substantial damage to the building, machinery and equipment and raw material
inventories. The Company's property and business interruption coverage with its
principal insurer provides for a maximum insurance recovery of $66 million. The
Company and its insurer reached a consensus that the total losses for business
interruption, insured incremental costs and property replacement would exceed
the maximum recoverable amount, resulting in the final settlement of the
insurance claim for the full $66 million reimbursement.
The final accounting for the insurance settlement and related costs is
presented below:
($ in millions) 2003
- ------------------------------------------------------------------
Insurance coverage reimbursement $ 66.0
Costs and expenses:
Business interruption costs 9.8
Insured incremental costs 15.8
Book value of property and equipment 11.7
Uninsured legal and investigation costs 11.4
- ------------------------------------------------------------------
Total costs and expenses 48.7
- ------------------------------------------------------------------
Gain on insurance settlement, net of related costs $ 17.3
==================================================================
RESTRUCTURING, IMPAIRMENT AND OTHER ITEMS
In December 2003, the Company recorded a $7.0 million charge associated with
a product designed by a customer and intended for production at our plastics
device plant in the United Kingdom. As a result of delays connected with the
regulatory approval of the product, the marketing and distribution partner for
our customer terminated its involvement with the product. The operating results
of the U.K. plant are significantly dependent on the success and timing of this
product. As a result of this decision and the resulting delay in the product
launch, including the possible termination of the product, management concluded
that the future cash flows to be generated by this plant will not be sufficient
to cover the book value of the property, plant and equipment at this site.
Accordingly, the Company recorded a $6.0 million impairment charge for the
difference between the carrying value and the expected fair value of these
assets. A related charge of $1.0 million was also recorded for statutory
post-employment benefit costs deemed probable of being paid. The Company
anticipates that future restructuring costs of approximately $1.5 million will
be incurred at this location in 2004.
In 2002, restructuring charges of $9.9 million were recorded in association
with the termination of an information systems implementation project ($6.9
million), a write-down of a technology company investment ($2.8 million), the
closure of a sales office in Korea ($0.1 million) and employee terminations at
the Nottingham, U.K., drug delivery site ($0.1 million). In 2001, the Company
recorded a net $2.9 million restructuring charge consisting of a $4.9 million
provision for the termination of 35 mid- and senior-level management positions,
offset by a $2.0 million adjustment related to the carrying value of an asset
held for sale from the 2000 restructuring program. As of December 31, 2003, the
remaining liability for all restructuring programs was $1.4 million, relating to
post-employment benefit obligations to be paid during 2004.
In 2002, the Company's subsidiary in Argentina recorded a foreign exchange
gain of $1.7 million on assets denominated in non-peso currencies due to the
devaluation of the Argentine peso.
INTEREST EXPENSE (NET)
The following table summarizes the Company's net interest expense for the
three-year period ended December 31, 2003:
($ in millions) 2003 2002 2001
- -----------------------------------------------------------------
Interest expense $ 10.4 $ 11.3 $ 14.3
Capitalized interest (0.7) (0.7) (0.8)
Interest income (2.2) (1.1) (1.5)
- -----------------------------------------------------------------
Interest expense (net) $ 7.5 $ 9.5 $ 12.0
=================================================================
Net interest expense declined $2.0 million in 2003 versus 2002 levels. The
majority of the decrease is due to interest income generated from advances made
to customers in connection with tooling and mold design projects. The remaining
decrease in 2003 net interest expense is attributed to lower interest rates, as
average debt levels remained essentially
constant with those of 2002. Net interest expense in 2002 declined $2.5 million
versus 2001 levels due to lower average debt levels and interest rates. The
lower debt levels in 2002 were generated by the $28 million fourth quarter 2001
proceeds received from the sale of the contract manufacturing and packaging
operation (see "Discontinued Operations"). Debt levels also benefited from a tax
refund received in 2002 associated with the divestiture of the contract
manufacturing and packaging business and a production facility in Puerto Rico.
INCOME TAXES
The effective tax rate on consolidated income from continuing operations was
35.6% in 2003, 24.0% in 2002 and 30.7% in 2001. The 2003 impairment charge in
the United Kingdom did not result in a tax benefit as management does not expect
to generate future taxable income in the specific U.K. legal entity sufficient
to utilize net operating loss carryforwards. Additionally, management provided a
$0.5 million valuation allowance on a deferred tax asset connected with this
plant that is now unlikely to be realized. These items increased the 2003
effective tax rate by 5.6%. A $2.4 million tax benefit from a change in U.S. tax
law related to loss disallowance rules, partially offset by the tax impact of a
foreign exchange gain in Argentina and a non-deductible restructuring charge
related to the impairment of a technology investment, resulted in an 8% decrease
in the 2002 effective tax rate. A non-taxable adjustment to the carrying value
of an asset held for sale resulted in a 2.3% decrease in the 2001 effective tax
rate.
EQUITY IN AFFILIATES
The contribution to earnings from a 25% ownership interest in Daikyo Seiko,
Ltd. and a 49% ownership interest in three companies in Mexico was income of
$1.6 million in 2003, a $0.3 million loss in 2002, and income of $0.5 million in
2001. The affiliate income increase is primarily related to Daikyo's strong
results in 2003, reflecting a record sales year, including export sales to the
U.S. market distributed by West. The results from the Mexican affiliates
improved to almost break-even for 2003, following losses in 2002 which included
costs associated with the restructuring of plant operations.
Company purchases from all affiliates totaled approximately $18.4 million in
2003 and $11.5 million in 2002, the majority of which relates to a
distributorship agreement allowing the Company to purchase and re-sell Daikyo
products. Sales to affiliates were $0.7 million and $1.0 million in 2003 and
2002, respectively.
INCOME FROM CONTINUING OPERATIONS
Net income from continuing operations in 2003 was $31.9 million, or $2.19
per diluted share. Results for 2003 included a net gain from an insurance
settlement of $17.3 million ($12.1 million, net of tax), or $0.83 per share, and
asset impairment and post-employment benefit charges at the U.K. device
operation of $7.0 million ($7.5 million including a related tax charge), or
$0.52 per share.
The Company's 2002 net income from continuing operations was $12.8 million,
or $0.89 per share. These results included restructuring charges of $9.9 million
($7.4 million, net of tax), or $0.51 per share, primarily related to the
termination of an information systems project and a write-down of an investment
in a genetic research technology company. Results also included $0.8 million, or
$0.06 per share, of severance and plant shutdown costs from the Company's
affiliates in Mexico, of which it owns 49%. Offsetting these costs was a $1.7
million ($0.8 million, net of tax), or $0.05 per share, foreign exchange gain
associated with the devaluation of the Argentine peso and a $2.4 million, or
$0.17 per share, tax benefit associated with the 2001 sale of a manufacturing
facility in Puerto Rico.
Net income from continuing operations in 2001 was $19.7 million, or $1.37 per
diluted share. Results in 2001 included a restructuring charge of $2.9 million
($1.3 million, net of tax), or $.09 per share. The charge consisted of a $4.9
million ($3.3 million, net of tax) employee severance provision, offset by a
$2.0 million adjustment to the carrying value of a plastic device manufacturing
facility held for sale from the 2000 restructuring program.
DISCONTINUED OPERATIONS
On December 4, 2002, the Company sold its consumer healthcare research unit
for $2.0 million to Concentrics Research, LLC, a company formed by the former
employee management team and Bindley Capital Partners, LLC. As a result of
receiving an offer to purchase the business, the Company reduced the carrying
value of the assets to fair market value in the third quarter of 2002, resulting
in a pre-tax charge of $0.6 million.
In connection with the sale of the contract manufacturing and packaging unit
in 2001, the Company was required to hold $4.3 million of the proceeds in a
trust account at December 31, 2001, for the payment of certain debentures in
2002. The payment of these debentures resulted in a $0.4 million, or $0.03 per
share, loss recorded in discontinued operations in 2002.
The Company also recorded a $5.9 million, or $0.40 per share, tax benefit in
discontinued operations connected with the disposition of the contract
manufacturing and packaging business. This tax benefit and related refund
resulted from a change in U.S. tax law in 2002 related to loss disallowance
rules.
In 2001, the Company sold all the operating assets of its contract
manufacturing and packaging business unit to DPT Lakewood, Inc. for $29.8
million, consisting of cash of $28 million and a $1.8 million note, which was
paid in 2003. The sale resulted in a net loss of $25.2 million, or $1.76 per
share.
LIQUIDITY AND CAPITAL RESOURCES
The cash balance at December 31, 2003, was $37.8 million and working capital
totaled $97.8 million, resulting in a ratio of current assets to current
liabilities of 1.8 to 1. Included in working capital is a $41.0 million
receivable due from our insurance provider in connection with the Kinston
accident. This receivable was collected in February 2004. The increase in
working capital due to the insurance receivable was largely offset by increased
accounts payable (reflecting amounts due on construction projects and
implementation of cash management programs in Europe), accrued expenses (costs
and obligations associated with the Kinston accident and higher incentive
compensation accruals) and deferred tax liabilities (tax impact of gain realized
on the Kinston insurance settlement). Consolidated debt totaled $175.0 million
at December 31, 2003. Debt to total invested capital (total debt and
shareholders' equity) was 40.5% at December 31, 2003, a 6.0 percentage point
improvement over year-end 2002 with shareholders' equity benefiting from
favorable currency translation on non-U.S. dollar net assets.
Cash flows generated from operations totaled $69.2 million in 2003, compared
to $45.7 million in 2002. The increase in cash flow largely resulted from the
strong performance of the Pharmaceutical Systems segment, particularly in
Europe.
Capital spending for 2003 totaled $60.8 million. The reconstruction of the
Kinston molding operation accounts for $14.1 million of the 2003 capital spent.
Other major capital projects included the expansion of the Stolberg, Germany,
metal and plastics facility ($6.3 million), additional manufacturing capacity
for the Westar product line at the Jersey Shore, Pa., plant ($5.2 million) and
the finalization of expansion of prefilled injection rubber molding and other
operations in Eschweiler, Germany, and Le Nouvion, France ($5.1 million). In
addition to the capital spending noted above, the Company paid $2.0 million to
acquire land and a vacant building under an economic development grant with
Lenoir County, N.C. Under the terms of the agreement, the County will reimburse
the purchase price in annual increments as long as the Company maintains minimum
capital investment and workforce conditions. The Company anticipates that total
2004 capital spending will be approximately $57.0 million, with approximately
$4.5 million needed to complete the Kinston molding facility reconstruction and
$5.5 million associated with permanently expanding rubber compounding capacity
at plants in St. Petersburg, Fla., and Kearney, Neb. The remaining $47.0 million
of projected 2004 capital spending is targeted for new product and expansion
projects, cost savings programs and manufacturing operations, principally in the
Pharmaceutical Systems segment. The receipt of the insurance proceeds in 2004
will be used to fund the capital spending projects at Kinston and other
locations, as well as other general Corporate purposes, including reducing
outstanding debt.
Cash provided by investing activities in 2003 includes net insurance proceeds
related to the Kinston accident of $2.2 million, consisting of $25.0 million in
cash advances from our insurer offset by $22.8 million of cash payments related
to business interruption and other insured costs. The remaining $41.0 million of
the insurance settlement was received in February 2004. Other 2003 investing
cash flows included the receipt of a $2.0 million payment of an installment note
received from the 2001 sale of the contract manufacturing and packaging
business, and $1.5 million of repayments of advances made to customers in
connection with funding the development of molds and tools to be used in the
production of customer products.
Financing cash flows include proceeds from stock option exercises of $3.0
million and dividends paid to shareholders totaling $11.8 million ($0.81 per
share).
The following table summarizes the Company's contractual obligations at
December 31, 2003, and the effect the obligations are expected to have on its
liquidity and cash flow in future periods:
Payments Due by Period
Less
than 1 1 to 3 4 to 5 After 5
($ in millions) year years years years Total
- --------------------------------------------------------------------------------
Unconditional purchase
obligations $ 2.8 $ -- $ -- $ -- $ 2.8
Notes payable 8.0 -- -- -- 8.0
Long-term debt -- 67.0 -- 100.0 167.0
Operating lease
obligations 7.2 13.1 12.4 25.1 57.8
- --------------------------------------------------------------------------------
Total contractual
obligations $ 18.0 $ 80.1 $ 12.4 $ 125.1 $ 235.6
================================================================================
The Company also has a $0.5 million letter of credit supporting the payment
of insurance obligations assumed by the acquirer of the contract manufacturing
and packaging business.
The Company's principal source of short- and medium-term liquidity is a
$125.0 million multi-currency revolving credit facility with a group of six
banks. The credit agreement consists of a $55.0 million, 364-day line of credit
renewable annually each July at the option of the banks and a $70.0 million
committed revolving credit facility maturing in July 2005. Interest costs on
these facilities are charged at the applicable London Inter-Bank Offering Rates
(LIBOR) plus a margin dependent on the Company's debt to total capital ratio.
Commitment fees on these agreements also fluctuate according to the Company's
debt to total capital ratio with a maximum commitment fee of 30 basis points on
the 364-day facility and 25 basis points on the five-year facility. The credit
agreement contains several compliance covenants, the most restrictive of which
is the requirement not to exceed a debt to total capital ratio of 55%. Failure
to meet this or other debt covenants would cause all borrowings under the
revolving credit facility, as well as the $100.0 million senior notes, to become
immediately due and payable.
The Company believes that its financial condition, capitalization structure
and expected income from operations will be sufficient to meet the Company's
future cash requirements, at least through July 2005, at which time the
Company's revolving credit facility expires. The Company anticipates refinancing
the existing facilities in the second quarter of 2004.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Financial Review discusses consolidated financial statements that are
prepared in accordance with accounting principles generally accepted in the
United States. The application of these principles requires management to make
estimates and assumptions, some of which are subjective and complex, that affect
the amounts reported in the consolidated financial statements. Management
believes the following accounting policies and estimates are critical to
understanding and evaluating the results of operations and financial position of
the Company:
REVENUE RECOGNITION: Sales of manufactured components are recorded at the
time title passes. Some customers receive pricing rebates upon attaining
established sales volumes. Management records rebate costs based on its
assessment of the likelihood that these volumes will be attained. Revenue
associated with drug delivery systems development is recognized as services are
provided. The timing of non-refundable licensing fee recognition is subject to
management's estimate of future costs to be incurred on the related development
agreement.
IMPAIRMENT OF ASSETS: The Company reviews goodwill and long-lived assets
(principally property, plant and equipment and patents) on an annual basis and
whenever circumstances indicate that the carrying value of these assets may not
be recoverable. Goodwill is tested for impairment as part of the reporting unit
to which it belongs. The Company has determined its reporting units to be the
Americas, Europe/Asia and Device Group divisions of the Pharmaceutical Systems
segment, and the drug delivery and clinical services units of the Drug Delivery
Systems segment. For assets to be held and used in the business, management
estimates the future cash flows to be derived from the related asset or business
unit. For other assets held for sale, management determines fair value by
estimating the anticipated proceeds to be received upon the sale of the asset.
Changes in management's estimate of fair value, including management's estimate
of future cash flows, could have a material impact on the Company's future
results of operations and financial position.
The majority of the Company's assets are associated with profitable
operations within the Pharmaceutical Systems segment. As discussed earlier, the
Company did record an impairment charge associated with its U.K. Device Group
facility. Unexpected changes in business patterns, plant consolidation or
competition could result in similar impairments of equipment associated with
other specific products in the future. Estimating future cash flows is
especially difficult where new product launches are involved. The Company's
introduction of a delivery system for the reconstitution of lyophilized
injectable drug products in 2002 has not yet resulted in commercial agreements.
The success of the product launch and long-term customer acceptance will be
critical in achieving the recoverability of its December 31, 2003, net book
value investment in inventories, equipment and license rights of $3.1 million.
The Company continues to seek commercial partners for this product.
In the drug delivery unit, the Company's revenue projections include
estimated licensing revenues, primarily dependent on the success of the
Company's acquired technologies, including ChiSys. These technologies have a
book value of $5.5 million at December 31, 2003, and are being amortized over
the related remaining patent terms. Management conducted an extensive review of
many potential projects utilizing these technologies and determined that the
probable future cash flows support the carrying value of the assets. After
pursuing near-term opportunities on other projects, management refocused on
projects utilizing these platforms in the second half of 2003. This additional
focus should result in significant advancement of the clinical trials utilizing
three primary technology platforms; however, if acceptable progress is not made
against internal targets, management will reassess future cash flows projected
for this business. Management anticipates certain ChiSys and other related
technology licensing agreements will be completed in 2004 resulting in
significantly improved revenues for this unit, but break-even results are not
anticipated in the near term.
The Company has also reviewed the operating projections for the clinical
services unit, which generated an operating loss in 2003 and 2002 following
several years of positive performance. Goodwill associated with this unit was
$2.0 million at December 31, 2003. This business unit has experienced
significant revenue growth relative to the poor performance of late 2002 and the
first half of 2003, and the backlog of projects has more than doubled over prior
year levels. Management projects that this business unit should return to
profitability in 2004, and would also expect to recover the book value of the
assets in the event of a decision to exit this business.
EMPLOYEE BENEFITS: The measurement of the obligations under the Company's
defined benefit pension and post-retirement medical plans are subject to a
number of assumptions. These include the rate of return on plan assets and the
rate at which the future obligations are discounted to present value. For U.S.
plans, which account for over 90% of global plan assets, the long-term rate of
return assumption remained at 9.0%. This return assumption was determined by
reviewing the expected mix of plan assets (approximately 65% equity and 35% debt
securities) and the projected return over a 10-year period. The discount rate
was reduced 50 basis points to 6.0% on December 31, 2003, to reflect current
market conditions. Changes in these estimates, including the market performance
of plan assets and other actuarial assumptions, could have a material impact on
the Company's future results of operations and financial position. Every 25
basis point reduction in the long-term rate of return assumption would increase
pension expense by approximately $0.4 million. A 25 basis point reduction in the
discount rate would increase pension expense by approximately $0.6 million. In
addition, restructuring events such as plant closures or changes in pension plan
provisions could result in curtailment or settlement of pension plan
obligations, which would result in gain or loss recognition in the period when
such an event occurs.
INCOME TAXES: The Company estimates income taxes payable based upon current
domestic and international tax legislation. In addition, deferred income tax
assets and liabilities are established to recognize differences between the tax
basis and financial statement carrying values of the Company's assets and
liabilities. Valuation allowances are recorded to reduce deferred tax assets to
amounts that are more likely than not to be realized. The recoverability of tax
assets is subject to the Company's estimates of future profitability, generally
at the local subsidiary company and country level. Changes in tax legislation,
business plans and other factors may affect the ultimate recoverability of tax
assets or final tax payments, which could result in adjustments to tax expense
in the period such change is determined.
Please refer to Note 1: Summary of Significant Accounting Policies and Note
21: New Accounting Standards of the Notes to Consolidated Financial Statements
of the 2003 Annual Report to Shareholders for additional information on
accounting and reporting standards considered in the preparation and
presentation of the Company's financial statements.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
Certain statements contained in this Report or in other Company documents and
certain statements that may be made by management of the Company orally may
contain forward-looking statements as defined in the Private Securities
Litigation Reform Act of 1995. These statements can be identified by the fact
that they do not relate strictly to historic or current facts. They use 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. 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.
Because actual results are affected by risks and uncertainties, the Company
cautions investors that actual results may differ materially from those
expressed or implied in any forward-looking statement.
It is not possible to 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, but are not limited to: sales demand;
timing of customers' projects; successful development of proprietary drug
delivery technologies, systems and products, including but not limited to risks
associated with clinical trials and with the creation, use and defense of
intellectual property; regulatory, licensee and/or market acceptance of products
based on those technologies or generic versions of commercial products;
competitive pressures; the strength or weakness of the U.S. dollar; inflation;
the cost and availability of raw materials; the availability of credit
facilities; and statutory tax rates.
With respect to the explosion and fire at the Company's Kinston, N.C., plant,
the following factors should also be taken into consideration: the timely
completion of the new production facility at Kinston and customers' approval of
the facility and products produced there, and achieving costefficient levels of
production in the new facility; the costs associated with business interruption
losses; the unpredictability of existing and future possible litigation related
to the explosion and the adequacy of insurance recoveries for costs associated
with such litigation; government actions or investigations affecting the
Company; the ability of the Company to continue to meet production requirements
from other plant sites and third parties in a timely manner; the extent of
uninsured costs for, among other things, legal and investigation services and
incremental insurance; and regulatory approvals and customer acceptance of goods
from alternate sites.
The Company assumes no obligation to update forwardlooking statements as
circumstances change. Investors are advised, however, to consult any further
disclosures the Company makes on related subjects in the Company's 10-K, 10-Q
and 8-K reports.
CONSOLIDATED STATEMENTS OF INCOME
West Pharmaceutical Services, Inc. and Subsidiaries for the years ended December 31, 2003, 2002 and 2001.
(in thousands, except per share data) 2003 2002 2001
- -----------------------------------------------------------------------------------------------------
Net sales $ 490,700 $ 419,700 $392,300
Cost of goods and services sold 334,900 302,100 277,500
- -----------------------------------------------------------------------------------------------------
Gross profit 155,800 117,600 114,800
Selling, general and administrative expenses 111,000 82,600 72,000
Insurance settlement (17,300) -- --
Restructuring and impairment charges 7,000 9,900 2,900
Other expense (income), net 600 (1,600) --
- -----------------------------------------------------------------------------------------------------
Operating profit 54,500 26,700 39,900
Interest expense 9,700 10,600 13,500
Interest income (2,200) (1,100) (1,500)
- -----------------------------------------------------------------------------------------------------
Income before income taxes and minority interests 47,000 17,200 27,900
Provision for income taxes 16,700 4,100 8,600
Minority interests -- -- 100
- -----------------------------------------------------------------------------------------------------
Income from consolidated operations 30,300 13,100 19,200
Equity in net income (loss) of affiliated companies 1,600 (300) 500
- -----------------------------------------------------------------------------------------------------
Income from continuing operations 31,900 12,800 19,700
Discontinued operations, net of tax -- 5,600 (24,900)
- -----------------------------------------------------------------------------------------------------
Net income (loss) $ 31,900 $ 18,400 $ (5,200)
=====================================================================================================
Net income (loss) per share:
Basic:
Continuing operations $ 2.20 $ .89 $ 1.38
Discontinued operations -- .39 (1.74)
- -----------------------------------------------------------------------------------------------------
$ 2.20 $ 1.28 $ (.36)
- -----------------------------------------------------------------------------------------------------
Assuming dilution:
Continuing operations $ 2.19 $ .89 $ 1.37
Discontinued operations -- .39 (1.73)
- -----------------------------------------------------------------------------------------------------
$ 2.19 $ 1.28 $ (.36)
- -----------------------------------------------------------------------------------------------------
Average common shares outstanding 14,513 14,434 14,336
Average shares assuming dilution 14,546 14,434 14,348
- -----------------------------------------------------------------------------------------------------
Dividends declared per common share $ .82 $ .78 $ .74
=====================================================================================================
The accompanying notes are an integral part of the financial statements.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
West Pharmaceutical Services, Inc. and Subsidiaries for the years ended December 31, 2003, 2002 and 2001.
(in thousands) 2003 2002 2001
- -----------------------------------------------------------------------------------------------------
Net income (loss) $ 31,900 $ 18,400 $ (5,200)
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments 31,200 16,500 (9,700)
Unrealized gains (losses) on securities of affiliates 600 (300) (100)
Minimum pension liability adjustments 300 (2,300) (2,800)
Cumulative effect of change in accounting principle for
derivatives and hedging activities -- -- (200)
Net realized losses on derivative instruments 200 200 100
Unrealized losses on derivatives -- (100) (200)
- -----------------------------------------------------------------------------------------------------
Comprehensive income (loss) $ 64,200 $ 32,400 $(18,100)
=====================================================================================================
The accompanying notes are an integral part of the financial statements.
CONSOLIDATED BALANCE SHEETS
West Pharmaceutical Services, Inc. and Subsidiaries at December 31, 2003 and 2002.
(in thousands, except per share data) 2003 2002
- -----------------------------------------------------------------------------------------------------
ASSETS
- -----------------------------------------------------------------------------------------------------
Current assets:
Cash, including cash equivalents $ 37,800 $ 33,200
Accounts receivable 73,900 66,600
Inventories 48,000 41,300
Insurance receivable 41,000 --
Income tax refundable 1,200 3,600
Deferred income taxes 6,100 5,200
Other current assets 8,700 11,900
- -----------------------------------------------------------------------------------------------------
Total current assets 216,700 161,800
- -----------------------------------------------------------------------------------------------------
Property, plant and equipment 563,600 499,600
Less accumulated depreciation and amortization 307,900 276,300
- -----------------------------------------------------------------------------------------------------
255,700 223,300
Investments in and advances to affiliated companies 22,200 18,000
Goodwill 41,500 35,500
Pension asset 50,500 54,700
Deferred income taxes 20,500 19,900
Patents 6,900 7,300
Other assets 9,600 9,100
- -----------------------------------------------------------------------------------------------------
Total Assets $623,600 $529,600
=====================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ -- $ 11,700
Notes payable 8,000 4,100
Accounts payable 29,400 19,200
Accrued expenses:
Salaries, wages and benefits 24,500 17,000
Income taxes payable 8,400 9,400
Restructuring costs 1,400 1,400
Deferred income taxes 16,600 2,400
Other 30,600 23,000
- -----------------------------------------------------------------------------------------------------
Total current liabilities 118,900 88,200
- -----------------------------------------------------------------------------------------------------
Long-term debt, excluding current portion 167,000 159,200
Deferred income taxes 44,800 48,500
Other long-term liabilities 35,300 32,200
- -----------------------------------------------------------------------------------------------------
Total liabilities 366,000 328,100
- -----------------------------------------------------------------------------------------------------
Commitments and contingencies
Shareholders' equity:
Preferred stock, shares authorized: 3,000;
shares issued and outstanding: 2003 - 0; 2002 - 0
Common stock, par value $.25 per share; shares authorized: 50,000;
shares issued: 2003 - 17,165; 2002 - 17,165;
shares outstanding: 2003 - 14,632; 2002 - 14,480 4,300 4,300
Capital in excess of par value 30,100 30,900
Retained earnings 281,200 261,200
Accumulated other comprehensive income (loss) 18,900 (13,400)
- -----------------------------------------------------------------------------------------------------
334,500 283,000
Less treasury stock, at cost (2003 - 2,533; 2002 - 2,685) (76,900) (81,500)
- -----------------------------------------------------------------------------------------------------
Total shareholders' equity 257,600 201,500
- -----------------------------------------------------------------------------------------------------
Total Liabilities and Shareholders' Equity $623,600 $529,600
=====================================================================================================
The accompanying notes are an integral part of the financial statements.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
West Pharmaceutical Services, Inc. and Subsidiaries for the years ended December 31, 2003, 2002 and 2001.
Accumulated
Capital in other
Common excess of Retained comprehensive Treasury
(in thousands, except per share data) stock par value earnings income (loss) stock Total
- --------------------------------------------------------------------------------------------------------------------------------
Balance, January 1, 2001 $ 4,300 $ 32,100 $ 269,800 $ (14,500) $ (86,900) $ 204,800
- --------------------------------------------------------------------------------------------------------------------------------
Net (loss) (5,200) (5,200)
Shares issued under stock plans (500) 1,300 800
Shares repurchased (100) (100)
Cash dividends declared ($.74 per share) (10,600) (10,600)
Changes - other comprehensive (loss) (12,900) (12,900)
- --------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2001 4,300 31,600 254,000 (27,400) (85,700) 176,800
- --------------------------------------------------------------------------------------------------------------------------------
Net income 18,400 18,400
Shares issued under stock plans (700) 4,300 3,600
Shares repurchased (100) (100)
Cash dividends declared ($.78 per share) (11,200) (11,200)
Changes - other comprehensive income 14,000 14,000
- --------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2002 4,300 30,900 261,200 (13,400) (81,500) 201,500
- --------------------------------------------------------------------------------------------------------------------------------
Net income 31,900 31,900
Shares issued under stock plans (800) 4,600 3,800
Cash dividends declared ($.82 per share) (11,900) (11,900)
Changes - other comprehensive income 32,300 32,300
- --------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2003 $ 4,300 $ 30,100 $ 281,200 $ 18,900 $ (76,900) $ 257,600
================================================================================================================================
The accompanying notes are an integral part of the financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
West Pharmaceutical Services, Inc. and Subsidiaries for the years ended December 31, 2003, 2002 and 2001.
(in thousands) 2003 2002 2001
- ----------------------------------------------------------------------------------------------------------------------
Cash flows provided by (used in) operating activities of continuing operations:
Net income (loss) $ 31,900 $ 18,400 $ (5,200)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities of continuing operations:
Income from discontinued operations -- (5,600) (300)
Loss on disposal of discontinued operations -- -- 25,200
Depreciation and amortization 33,000 33,000 31,900
Gain on insurance settlement (28,700) -- --
Restructuring and impairment charges 6,000 8,600 (2,200)
Loss on sales of equipment and other assets 1,400 600 600
Stock-based compensation 1,000 100 400
Deferred income taxes 7,500 1,500 1,400
Pension and other retirement plans 6,000 (4,800) (10,000)
(Equity) loss in undistributed earnings of affiliated companies, net (1,600) 200 (300)
Changes in assets and liabilities, net of effects of discontinued operations:
(Increase) decrease in accounts receivable (1,200) (3,700) (7,500)
(Increase) decrease in inventories (2,800) (4,700) (900)
Decrease (increase) in other current assets 600 (2,800) 700
Increase (decrease) in other current liabilities 16,100 6,000 3,000
Other operating items -- (1,100) 700
- ----------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities of continuing operations 69,200 45,700 37,500
- ----------------------------------------------------------------------------------------------------------------------
Cash flows (used in) provided by investing activities:
Property, plant and equipment acquired (60,800) (37,700) (45,200)
Insurance proceeds received for property damage 2,200 -- --
Land acquired under government grant (2,000) -- --
Proceeds from sales of assets 2,000 2,400 31,300
Deposit held in trust from sale of assets -- 4,300 (4,300)
Advance to affiliate -- (1,000) --
Payments for acquisitions -- -- (1,100)
Customer advances, net of repayments 1,500 (300) (1,500)
- ----------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities of continuing operations (57,100) (32,300) (20,800)
- ----------------------------------------------------------------------------------------------------------------------
Cash flows (used in) provided by financing activities:
Borrowings (repayments) under revolving credit agreements, net 5,400 (10,400) (2,400)
Repayment of industrial revenue bond -- (6,100) --
Repayment of subordinated debenture -- (4,300) --
Repayment of other long-term debt (12,100) (800) (5,200)
Borrowings (repayments) of other notes payable, net 3,400 (3,500) 1,700
Issuance of common stock 3,000 3,300 700
Dividend payments (11,800) (11,100) (10,500)
Purchase of treasury stock -- (100) (100)
- ----------------------------------------------------------------------------------------------------------------------
Net cash used in financing activities of continuing operations (12,100) (33,000) (15,800)
- ----------------------------------------------------------------------------------------------------------------------
Net cash provided by discontinued operations -- 8,200 600
- ----------------------------------------------------------------------------------------------------------------------
Effect of exchange rates on cash 4,600 2,500 (2,100)
- ----------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 4,600 (8,900) (600)
Cash and cash equivalents at beginning of year 33,200 42,100 42,700
- ----------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 37,800 $ 33,200 $ 42,100
======================================================================================================================
Supplemental cash flow information:
Interest paid, net of amounts capitalized $ 9,700 $ 10,600 $ 13,500
Income taxes paid (refunded) $ 8,700 $ (4,700) $ 5,700
======================================================================================================================
The accompanying notes are an integral part of the financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION: The financial statements are prepared in conformity
with accounting principles generally accepted in the United States. These
principles require management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and revenue and expenses and the
disclosure of contingencies in the financial statements. Actual amounts realized
may differ from these estimates.
PRINCIPLES OF CONSOLIDATION: In deciding which entities should be reported on
a consolidated basis, the Company first determines whether the entity is a
variable interest entity ("VIE") as defined in Financial Accounting Standards
Board ("FASB") Interpretation No. 46. If an entity meets the criteria for VIE
status, the Company consolidates that entity if the Company has the obligation
to absorb more than 50% of the entity's expected losses or receive more than 50%
of the entity's expected residual returns. If an entity does not meet the
criteria for VIE status, the Company consolidates those in which it has control.
Investments in joint ventures and other companies in which the Company does not
have control, but the ability to exercise significant influence over operating
and financial policies, are accounted for by the equity method. Investments in
which the Company does not have the ability to exercise significant influence
over operating and financial policies are carried at cost. Material intercompany
transactions and accounts are eliminated in consolidation. Certain items have
been reclassified to conform to current classifications.
CASH AND CASH EQUIVALENTS: Cash equivalents include time deposits,
certificates of deposit and all highly liquid debt instruments with original
maturities of three months or less.
ACCOUNTS RECEIVABLE: The Company's accounts receivable balance at December
31, 2003 and 2002, was net of an allowance for doubtful accounts of $700 for
both periods. The Company records the allowance based on a specific
identification methodology.
INVENTORIES: Inventories are valued at the lower of cost or market. The cost
of inventories located in the United States is determined on the last-in,
first-out (LIFO) method. The cost of inventories located outside the United
States is determined principally on the average cost method.
FOREIGN CURRENCY TRANSLATION: Foreign currency transaction gains and losses
and translation gains and losses of subsidiaries operating in high-inflation
economies are recognized in the determination of net income. Foreign currency
translation adjustments of other subsidiaries and affiliates operating outside
the United States are accumulated in other comprehensive income, a separate
component of shareholders' equity.
FINANCIAL INSTRUMENTS: The Company records all derivatives on the balance
sheet at fair value. The change in fair value of a derivative designated and
qualified as part of a hedging transaction is recorded each period in earnings
or other comprehensive income depending on the type of hedging instrument. The
change in fair value of a derivative instrument with no hedging designation or
purpose is recognized immediately into earnings.
The Company uses interest rate swaps and forward exchange contracts to
minimize the economic exposure related to fluctuating interest and foreign
exchange rates. Interest rate swaps are designated as cash flow hedges;
therefore, unrealized gains and losses are recorded in other comprehensive
income. As the underlying transaction occurs, any unrealized gains or losses on
the related hedge are reclassified from other comprehensive income to the
statement of income (interest expense), offsetting the income effects of the
transaction to which they relate. Gains and losses on forward exchange contracts
designated as fair value hedges, primarily related to raw material purchase
commitments, are deferred and recognized as part of the underlying transaction.
Forward contracts that do not qualify for hedge accounting are recorded at fair
value with any gains or losses recognized in other (income) expense. The Company
also engages in hedges of its net investments in foreign operations in order to
minimize the economic exposure to fluctuating foreign exchange rates. Fair value
adjustments for hedges of the net investment in foreign operations are reported
in other comprehensive income as foreign currency translation adjustments and
are released to earnings upon disposal of the investment.
REVENUE RECOGNITION: Sales of manufactured components are recorded at the
time title passes. Some customers receive pricing rebates upon attaining
established sales volumes. Management records rebate costs based on its
assessment of the likelihood that these volumes will be attained. The Company
also establishes product return liabilities for customer quality claims when
such amounts are deemed probable and can be reasonably estimated.
Clinical service revenue and related direct costs are recognized as specific
contract terms are fulfilled. Fees for individual contract clinical services are
fixed upon execution of the contract and provide for payment for all work
performed. The termination of a contract typically results in no material
adjustments to the revenue or costs previously recognized.
Revenue associated with drug delivery systems development is recognized when
earned in accordance with the terms of contract research agreements with the
customer. Non-refundable license and milestone fees are recognized as revenue
when related services under the agreements are performed. The timing of
non-refundable licensing fee recognition is subject to management's estimate of
future costs to be incurred on the related development agreement.
For agreements with multiple deliverables, the Company assesses whether more
than one unit of accounting exists. If more than one unit exists, revenue for
each separate unit is recorded as earned.
SHIPPING AND HANDLING COSTS: Net sales includes shipping and handling costs
collected from customers in connection with the sale. Costs incurred for
shipping and handling are included in cost of sales.
PROPERTY, PLANT AND EQUIPMENT: Property, plant and equipment assets are
carried at cost. Maintenance and minor repairs and renewals are charged to
expense as incurred. Costs incurred for computer software developed or obtained
for internal use are capitalized for application development activities
and immediately expensed for preliminary project activities or
post-implementation activities. Upon sale or retirement of depreciable assets,
costs and related accumulated depreciation are eliminated, and gains or losses
are recognized in other (income) expense. Depreciation is computed principally
on the straight-line method over the estimated useful lives of the assets, or
the remaining term of the lease, if shorter.
GOODWILL AND OTHER INTANGIBLES: Goodwill and intangible assets with
indefinite lives are tested for impairment on at least an annual basis or more
frequently if an event occurs that indicates that there could be an impairment.
The first step of the impairment test compares the fair value of a reporting
unit to its carrying amount, including goodwill. If the carrying amount of the
reporting unit exceeds its fair value, the second step is performed. The second
step compares the carrying amount of the goodwill to its implied fair value. The
implied fair value is determined by allocating the fair value of the reporting
unit to all of the assets and liabilities of that unit as if the reporting unit
had been acquired in a business combination and the fair value of the reporting
unit was the purchase price paid to acquire the reporting unit. The excess of
the fair value of the reporting unit over the amounts assigned to its assets and
liabilities is the implied fair value of goodwill. If the fair value of the
goodwill is less than the carrying amount, an impairment loss is recorded.
Other intangible assets, including patents and licensed technology, are
recorded at cost and are amortized on a straight-line method over their useful
lives. The Company capitalizes patent application costs and expenses other costs
incurred in patent development.
TOOLING: The Company builds tools, molds and dies for certain customers. The
tooling is built and paid for by the Company and reimbursed by the customer
based upon the tooling agreement. Reimbursement is either in lump sum or as
units are produced under long-term supply agreements. At December 31, 2003 and
2002, other noncurrent assets included $3,500 and $5,000, respectively, of
unreimbursed tooling costs.
IMPAIRMENT OF LONG-LIVED ASSETS: Long-lived assets including property, plant
and equipment, and intangible assets subject to amortization are reviewed for
impairment whenever circumstances indicate that the carrying value of these
assets may not be recoverable. An asset is considered impaired if the carrying
value of the asset exceeds the sum of the future expected undiscounted cash
flows to be derived from the asset. Once an asset is considered impaired, an
impairment loss is recorded for the difference between the asset's carrying
value and its fair value. This loss is included in operating profit. For assets
to be held and used in the business, management determines fair value by
estimating the future cash flows to be derived from the asset and discounts
these flows to a net present value using an appropriate discount rate. For
assets held for sale or for investment purposes, management determines fair
value by estimating the anticipated proceeds to be received upon sale of the
asset.
RESEARCH AND DEVELOPMENT: Research, development and engineering expenditures
are for the creation and application of new or improved products and processes,
and drug delivery systems. Expenditures include primarily salaries and outside
services for those directly involved in research and development activities.
Research and development costs of $18,700 in 2003, $16,400 in 2002 and $13,000
in 2001, were expensed as incurred.
ENVIRONMENTAL REMEDIATION AND COMPLIANCE COSTS: Environmental remediation
costs are accrued when such costs are probable and reasonable estimates are
determinable. Cost estimates are not discounted and include investigation,
cleanup and monitoring activities; such estimates are adjusted, if necessary,
based on additional findings. In general, environmental compliance costs are
expensed. Environmental compliance costs at current operating sites are
capitalized if they increase the value of the property and/or prevent
environmental hazards from occurring.
LITIGATION: The Company is from time to time party to lawsuits arising from
its operations. The Company records liabilities when a loss is probable and can
be reasonably estimated. These estimates are based on an analysis made by
internal and external legal counsel which considers information known at the
time.
INCOME TAXES: Deferred income taxes are recognized by applying enacted
statutory tax rates, applicable to future years, to temporary differences
between the tax bases and financial statement carrying values of the Company's
assets and liabilities. Valuation allowances are recorded to reduce deferred tax
assets to amounts that are more likely than not to be realized. United States
income taxes and withholding taxes are accrued on the portion of earnings of
international subsidiaries and affiliates (which are corporate joint ventures)
intended to be remitted to the parent company.
STOCK-BASED COMPENSATION: The Company accounts for stock-based compensation
using the intrinsic value method prescribed in Accounting Principles Board (APB)
Opinion No. 25, "Accounting for Stock Issued to Employees," and related
interpretations. Accordingly, compensation cost for stock options is measured as
the excess, if any, of the quoted market price of the Company's stock at the
date of the grant over the amount an employee must pay to acquire the stock.
The Company has recorded stock-based compensation for employee restricted
stock awards and for director stock-based compensation. The Company did not
record compensation cost for stock options for the years ended 2003, 2002 and
2001, because stock option grants are at 100% of fair market value of the stock
on the grant date. The Company did not record compensation cost for shares
issued under the employee stock purchase plan as the plan meets the APB No. 25
criteria for a noncompensatory plan. If the fair value based method prescribed
in Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for
Stock-Based Compensation," had been applied to stock option grants and shares
issued under the employee stock purchase plan in the most
recent three years, the Company's net income (loss) and basic and diluted net
income (loss) per share would have been reduced as summarized below:
2003 2002 2001
- ------------------------------------------------------------------------
Net income (loss), as reported $ 31,900 $ 18,400 $ (5,200)
Add: Stock-based compensation
expense included in net income,
net of tax 600 100 300
Deduct: Total stock-based
compensation expense determined
under fair value based method
for all awards, net of tax (2,100) (1,500) (1,800)
- ------------------------------------------------------------------------
Pro forma net income (loss) $ 30,400 $ 17,000 $ (6,700)
========================================================================
Net income (loss) per share:
Basic, as reported $ 2.20 $ 1.28 $ (.36)
Basic, pro forma $ 2.09 $ 1.18 $ (.46)
Diluted, as reported $ 2.19 $ 1.28 $ (.36)
Diluted, pro forma $ 2.09 $ 1.18 $ (.46)
========================================================================
NET INCOME (LOSS) PER SHARE: Basic net income (loss) per share is computed by
dividing net income (loss) by the weighted average number of shares of common
stock outstanding during each period. Net income (loss) per share assuming
dilution considers the potential issuance of common shares under the Company's
stock option and award plans, based on the treasury stock method. The treasury
stock method assumes the use of exercise proceeds to repurchase common stock at
the average fair market value in the period.
NOTE 2: DISCONTINUED OPERATIONS
In December 2002, the Company sold its consumer healthcare research business
located in Indianapolis, Ind. This business unit was previously a part of the
Drug Delivery Systems segment. The sales price totaled $2,000, consisting of
$1,900 cash and $100 in escrow. Cash proceeds from the sale were used to repay
the Company's debt. During 2002 but prior to the sale of the business, the
Company recorded a goodwill impairment charge of $600; as a result, there was no
gain or loss recorded on the sale of the business. The results of this business
have been reflected as discontinued operations in the accompanying consolidated
financial statements for all periods presented.
In 2001, the Company sold its contract manufacturing and packaging business
located in Lakewood, N.J. The sales price totaled $29,800, consisting of $28,000
of cash and a $1,800 note which was paid in 2003. The proceeds, excluding $4,300
held in trust for the repayment of debentures, were used to repay outstanding
debt. As a result of the transaction, the Company recorded a $25,200, net of
tax, loss in 2001. The results of this business have been reflected as
discontinued operations in the accompanying consolidated financial statements
for all periods presented.
At December 31, 2001, the Company was required to hold $4,300 of the proceeds
from the contract manufacturing and packaging sale in trust for the payment of
debentures that the Company agreed to redeem as part of the sale. These
debentures were repaid in the first quarter of 2002 resulting in a $400, net of
tax, charge that was included in discontinued operations in 2002.
During 2002, the Company recorded a $5,900 tax benefit in income from
discontinued operations. The tax benefit and the related tax refund were
associated with the 2001 disposition of the contract manufacturing and
packaging business and was due to a change in U.S. tax law in 2002 related to
loss disallowance rules.
Net sales and income from discontinued operations were as follows:
2002 2001
- ------------------------------------------------------------------
Net sales $ 5,400 $ 66,000
- ------------------------------------------------------------------
Pretax (loss) income from
discontinued operations (700) 800
Pretax loss on disposal of
business segment -- (29,600)
Income tax benefit 6,300 3,900
- ------------------------------------------------------------------
Net income (loss) from
discontinued operations $ 5,600 $(24,900)
==================================================================
Net cash provided by (used in) discontinued operations were as follows:
2002 2001
- ------------------------------------------------------------------
Operating activities $ 8,300 $ 1,900
Property, plant and
equipment acquired (100) (1,300)
- ------------------------------------------------------------------
Net cash provided by
discontinued operations $ 8,200 $ 600
==================================================================
NOTE 3: ACQUISITIONS AND INVESTMENTS
In September 2002, the Company advanced $1,000 to its 49% owned affiliates
in Mexico in connection with a plant shutdown (see Note 14: Affiliated
Companies). The note is denominated in U.S. dollars at a 4% annual interest rate
with repayment due in 2005.
In 2001, the Company purchased the remaining 17.9% minority ownership of West
Pharmaceutical Services Hispania, S.A. for approximately $1,500. The purchase
price consisted of $1,100 of cash and $400 of notes payable. The purchase price
exceeded the net book value of the minority interest liability, resulting in
goodwill of $500.
NOTE 4: RESTRUCTURING AND IMPAIRMENT CHARGES
The following table details activity related to the Company's restructuring
obligations:
Severance Continuing Discontinued
and benefits Other operations operations Total
- -----------------------------------------------------------------------------------------------
Balance, December 31, 2000 $ 2,700 $ -- $ 2,700 $ 1,500 $ 4,200
- -----------------------------------------------------------------------------------------------
2001 Charge 4,900 (2,000) 2,900 -- 2,900
Non-cash write-offs 200 2,000 2,200 (500) 1,700
Cash payments (5,700) -- (5,700) (900) (6,600)
- -----------------------------------------------------------------------------------------------
Balance, December 31, 2001 2,100 -- 2,100 100 2,200
- -----------------------------------------------------------------------------------------------
2002 Charge 800 9,100 9,900 600 10,500
Non-cash write-offs -- (8,600) (8,600) (600) (9,200)
Cash payments (2,100) -- (2,100) -- (2,100)
- -----------------------------------------------------------------------------------------------
Balance, December 31, 2002 800 500 1,300 100 1,400
- -----------------------------------------------------------------------------------------------
2003 Charge 1,000 6,000 7,000 -- 7,000
Non-cash write-offs -- (6,000) (6,000) -- (6,000)
Cash payments (400) (500) (900) (100) (1,000)
- -----------------------------------------------------------------------------------------------
Balance, December 31, 2003 $ 1,400 $ -- $ 1,400 $ -- $ 1,400
===============================================================================================
In 2003, the Company recorded a $7,000 charge associated with a product
designed by a customer and intended for production at the Company's plastics
device plant located in the U.K., a part of the Pharmaceutical Systems segment.
The charge consisted of a $6,000 impairment of fixed assets, including related
asset retirement obligations, and a $1,000 provision for
statutory post-employment benefit obligations for approximately 70 employees. As
a result of delays connected with the regulatory approval of the product, the
marketing and distribution partner for the Company's customer terminated its
involvement with the product. As the Company's fair value projections for the
unit significantly relied on the achievement of sales from this agreement, the
carrying value of the long-lived assets could no longer be supported.
In 2002, the Company's continuing operations included a $9,900 restructuring
charge connected with the termination of an information systems implementation
project, an impairment of a technology company investment, the closure of a
sales office in Korea and employee terminations at the Nottingham, U.K., drug
delivery site. The $800 severance provision covered 19 employee terminations
connected with these actions that were completed in the fourth quarter of 2002.
In addition to severance, the restructuring charge included a $5,800 write-off
of the information systems implementation project, $500 for contract termination
fees related to the information systems project and a $2,800 impairment of the
Company's investment in a genotyping technology firm. In 2002, the firm
discontinued development activities and began marketing the technology for
license or sale. In connection with this change in strategy, the Company
recorded the impairment charge, bringing the investment in the firm to $500. The
Company also recorded a $600 goodwill impairment charge based on an offer to
purchase the consumer healthcare research business (see Note 2: Discontinued
Operations).
In 2001, the Company's continuing operations included a net restructuring
charge of $2,900. The charge consisted of a restructuring provision of $4,900
relating to the termination of mid- and senior-level management positions and a
$2,000 adjustment to the carrying value of the plastic device manufacturing
facility held for sale from the 2000 restructuring program. Final terminations
completed under this program totaled 35 positions.
The accrual balance at December 31, 2003, includes $1,400 of severance and
post-employment medical obligations. These obligations will be paid within the
next year.
NOTE 5: KINSTON
On January 29, 2003, the Company's Kinston, N.C., plant suffered an explosion
and related fire that resulted in six deaths, a number of injured personnel and
substantial damage to the building, machinery and equipment and raw material
inventories. The Company's property and business interruption insurance coverage
with its principal insurer provides for a maximum insurance recovery of $66,000.
In February 2004, the Company and its insurer reached a consensus that the total
losses for business interruption, insured incremental costs and property
replacement would exceed the maximum recoverable amount, resulting in the final
settlement of the insurance claim for the full $66,000 reimbursement. This
settlement is reflected in the Company's results as of December 31, 2003.
The accounting for the insurance settlement and related costs is presented
below:
2003
- -----------------------------------------------------------------
Insurance coverage reimbursement $ 66,000
Less costs and expenses
Business interruption costs 9,800
Insured incremental costs 15,800
Book value of property and equipment 11,700
- -----------------------------------------------------------------
Gain on insurance settlement $ 28,700
Uninsured costs incurred 11,400
- -----------------------------------------------------------------
Insurance settlement $ 17,300
================================================================
As of December 31, 2003, the Company had received $25,000 from its principal
insurer; therefore, the Company has recorded an insurance receivable of $41,000
as of December 31, 2003. The Company received payment of this receivable in
February of 2004.
During 2003, the Company purchased land from Lenoir County, N.C., for $2,000
on which the Company is in the process of rebuilding its compression molding
operation. Under the terms of the agreement, commencing in 2005, the County will
reimburse the purchase price of the land in yearly increments of $200 as long as
the Company complies with certain capital investment and employment conditions.
NOTE 6: OTHER INCOME (EXPENSE)
2003 2002 2001
- ------------------------------------------------------------------
Foreign exchange gains $ 500 $ 2,300 $ 100
Loss on sales of equipment
and other assets (1,400) (600) (600)
Other 300 (100) 500
- ------------------------------------------------------------------
$ (600) $ 1,600 $ --
==================================================================
In 2002, the Company's subsidiary in Argentina recorded a pre-tax foreign
currency exchange gain of $1,700 on net assets denominated in non-peso
currencies due to the devaluation of the Argentine peso.
NOTE 7: INCOME TAXES
Income before income taxes and minority interests was derived as follows:
2003 2002 2001
- -----------------------------------------------------------------
Domestic operations $ 24,100 $ (8,900) $ 17,400
International operations 22,900 26,100 10,500
- -----------------------------------------------------------------
$ 47,000 $ 17,200 $ 27,900
=================================================================
The related provision for income taxes consists of:
2003 2002 2001
- -----------------------------------------------------------------
Current provision:
Federal $ (1,600) $ (5,600) $ 1,900
State -- (200) 100
International 10,800 8,400 5,200
- ---------------------------------------------------------------------
9,200 2,600 7,200
- ---------------------------------------------------------------------
Deferred provision:
Federal 6,600 (800) 3,300
International 900 2,300 (1,900)
- ---------------------------------------------------------------------
7,500 1,500 1,400
- ---------------------------------------------------------------------
Provision for income taxes $ 16,700 $ 4,100 $ 8,600
=====================================================================
A reconciliation of the United States statutory corporate tax rate to the
Company's effective consolidated tax rate on income before income taxes and
minority interests follows:
2003 2002 2001
- ------------------------------------------------------------------
Statutory corporate tax rate 35.0% 35.0% 35.0%
Tax on international operations
(less than) in excess of
United States tax rate (6.4) (9.0) (1.9)
Valuation allowance adjustments 9.3 30.2 (2.7)
Foreign exchange gain -- 2.0 --
Loss disallowance adjustment -- (14.4) --
United States tax on repatriated
foreign earnings (1.5) (8.9) .5
State income taxes, net
of federal tax benefit (3.1) (10.0) (3.1)
Other 2.3 (.9) 2.9
- ------------------------------------------------------------------
Effective tax rate 35.6% 24.0% 30.7%
==================================================================
In the third quarter of 2002, the Company recorded a tax benefit associated
with the 2001 disposition of its contract manufacturing and packaging business
and the shutdown of a plastic device manufacturing facility. Of the total
benefit, $5,900 was recorded in discontinued operations and $2,400 was reflected
in continuing operations. The tax benefit and the related tax refund were a
result of a change in U.S. tax law in 2002 related to loss disallowance rules.
The net current and noncurrent components of deferred income taxes recognized
in the balance sheet at December 31 are as follows:
2003 2002
- ------------------------------------------------------------------
Current assets $ 6,100 $ 5,200
Noncurrent assets 20,500 19,900
Current liabilities (16,600) (2,400)
Noncurrent liabilities (44,800) (48,500)
- ------------------------------------------------------------------
$ (34,800) $ (25,800)
==================================================================
The following is a summary of the significant components of the Company's
deferred tax assets and liabilities as of December 31:
2003 2002
- ------------------------------------------------------------------
Deferred tax assets:
Net operating loss carryforwards $ 21,400 $ 17,400
Foreign/R&D tax credit carryforwards 8,000 5,800
Restructuring charges 500 2,100
Capital loss carryforwards 5,700 1,800
Other 9,700 7,500
Valuation allowance (26,100) (20,800)
- ------------------------------------------------------------------
Total deferred tax assets $ 19,200 $ 13,800
- ------------------------------------------------------------------
Deferred tax liabilities:
Accelerated depreciation $ 26,200 $ 24,700
Severance and deferred compensation 9,300 10,900
Kinston gain 15,800 --
Other 2,700 4,000
- ------------------------------------------------------------------
Total deferred tax liabilities $ 54,000 $ 39,600
- ------------------------------------------------------------------
Total deferred taxes $ (34,800) $(25,800)
==================================================================
At December 31, 2003, the Company had state and foreign operating tax loss
carryforwards of $78,200 and $34,000, respectively. These loss carryforwards are
available to apply against the future taxable income in the tax jurisdictions
that created the losses. Management estimates that of the total state and
foreign operating tax loss carryforwards, $78,200 and $34,000, respectively, are
unlikely to be utilized and therefore have been fully reserved. State loss
carryforwards expire as follows: $5,200 in 2005, $7,100 in 2006, $5,700 in 2007
and $60,200 after 2007. Foreign loss carryforwards will expire as follows: $400
in 2004, $9,900 in 2005, $500 in 2008 and $23,200 has no expiration date.
At December 31, 2003, undistributed earnings of foreign subsidiaries, on
which deferred income taxes have not been provided, amounted to $204,300. It is
the Company's intention to reinvest these undistributed earnings of foreign
subsidiaries, and it is not practicable to determine the amount of income or
withholding tax that would be payable upon the remittance of those earnings.
Such earnings would become taxable upon the sale or liquidation of foreign
subsidiaries or upon the remittance of dividends. Tax credits that would become
available upon distribution of such earnings could reduce income taxes then
payable at the U.S. statutory rate. As of December 31, 2003, the Company had
available foreign tax credit carryforwards of $6,900 expiring as follows: $300
in 2004, $400 in 2005, $300 in 2006, $2,600 in 2007 and $3,300 in 2008. Based
upon current estimates, management estimates that $2,900 may not be utilized and
therefore has been fully reserved. The Company has R&D credit carryforwards of
$1,100, of which $500 expires in 2022 and $600 expires in 2023.
The Internal Revenue Service (IRS) has completed and closed its audits of the
Company's U.S. tax returns through 1997. The IRS is currently conducting audits
of the 1998 and 1999 tax returns.
NOTE 8: SEGMENT INFORMATION
The Company's operations are comprised of two reportable segments:
Pharmaceutical Systems and Drug Delivery Systems. The Pharmaceutical Systems
segment focuses on the design, manufacture and distribution of stoppers,
closures, medical device components and assemblies made from elastomers, metals
and plastics. The Pharmaceutical Systems segment is composed of three operating
segments (the Americas, Europe/Asia and Devices) which have been aggregated.
These operating segments manufacture and sell similar products. The Drug
Delivery Systems segment consists of a research and development unit
concentrating on the commercialization of products utilizing the Company's
patented drug delivery technologies, and a clinical services unit that conducts
mainly Phase I and II clinical trials. The Company has aggregated these two
operating segments into a single reportable segment as neither meets the
quantitative thresholds for a reportable segment, and they meet the majority of
the aggregation criteria.
The Company's executive management evaluates the performance of these
operating segments based on operating profit and cash flow generation. General
Corporate expenses, restructuring charges and other items, are not reflected in
operating profit reviewed by segment management. Corporate segment assets
include pension assets, investments in affiliated companies and net assets of
discontinued operations. The accounting policies of the segments are the same as
those described in the summary of significant accounting policies.
The following table provides information on sales by significant product
group:
Sales by product group 2003 2002 2001
- ------------------------------------------------------------------
Pharmaceutical packaging $341,200 $286,200 $256,600
Disposable medical components 100,400 88,600 88,100
Personal care/food packaging 32,200 30,700 27,600
Laboratory and other services 9,600 7,300 4,100
- ------------------------------------------------------------------
Pharmaceutical Systems $483,400 $412,800 $376,400
Clinical services 5,400 5,300 7,800
Development/licensing revenue 1,900 1,600 8,100
- ------------------------------------------------------------------
Drug Delivery Systems $ 7,300 $ 6,900 $ 15,900
- ------------------------------------------------------------------
Net sales $490,700 $419,700 $392,300
==================================================================
The Pharmaceutical Systems segment includes sales to one customer of
approximately $58,100, $54,600 and $50,600 in 2003, 2002 and 2001, respectively.
The following table presents sales by the country in which the legal
subsidiary is domiciled and assets are located. Long-lived assets include
property, plant and equipment, patents and licensed technology.
Sales Long-lived assets
- -------------------------------------------------------------------------------
2003 2002 2001 2003 2002 2001
- -------------------------------------------------------------------------------
United States $246,800 $225,000 $218,300 $113,100 $111,300 $118,700
Germany 59,700 45,600 36,600 57,300 38,700 29,200
Other European
countries 146,000 114,900 103,400 74,500 64,700 52,500
Other 38,200 34,200 34,000 17,700 15,900 17,300
- -------------------------------------------------------------------------------
$490,700 $419,700 $392,300 $262,600 $230,600 $217,700
===============================================================================
The following table provides summarized financial information for the Company's
segments:
Pharmaceutical Drug Delivery
Systems Systems Corporate Consolidated
- -------------------------------------------------------------------------------------------------------------------------------
2003
- ----
Net sales $ 483,400 $ 7,300 $ -- $ 490,700
Operating profit (loss) 88,200 (17,500) (16,200) 54,500
Segment assets 468,800 15,200 139,600 623,600
Capital expenditures 58,400 400 2,000 60,800
Depreciation and amortization expense 29,400 1,800 1,800 33,000
2002
- ----
Net sales $ 412,800 $ 6,900 $ -- $ 419,700
Operating profit (loss) 65,100 (15,000) (23,400) 26,700
Segment assets 405,800 16,800 107,000 529,600
Capital expenditures 31,600 1,700 4,400 37,700
Depreciation and amortization expense 28,700 1,800 2,500 33,000
2001
- ----
Net sales $ 376,400 $ 15,900 $ -- $ 392,300
Operating profit (loss) 55,200 (4,300) (11,000) 39,900
Segment assets 376,400 20,700 111,100 508,200
Capital expenditures 39,400 1,200 4,600 45,200
Depreciation and amortization expense 27,300 1,800 2,800 31,900
===============================================================================================================================
NOTE 9: NET INCOME (LOSS) PER SHARE
The following table reconciles shares used in the calculation of basic net
income (loss) per share to the shares used in the calculation of net income
(loss) per share assuming dilution. There is no adjustment to the net income
(loss) of the Company in the calculation of net income (loss) per share assuming
dilution.
2003 2002 2001
- -------------------------------------------------------------------------------
Income from continuing operations $ 31,900 $ 12,800 $ 19,700
Discontinued operations, net of tax -- 5,600 (24,900)
- -------------------------------------------------------------------------------
Net income (loss) $ 31,900 $ 18,400 $ (5,200)
===============================================================================
Average common
shares outstanding 14,513 14,434 14,336
Assumed stock options
exercised and awards vested 33 -- 12
- -------------------------------------------------------------------------------
Average shares
assuming dilution 14,546 14,434 14,348
===============================================================================
For 2003, 2002 and 2001, stock options of 1,246,600, 2,117,900 and 862,700,
respectively, were excluded from the computation of diluted earnings per share
since the options' exercise prices were greater than the average market price
for the related periods.
NOTE 10: COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) consists of reported net income (loss) and other
comprehensive income (loss), which reflects revenue, expenses and gains and
losses that generally accepted accounting principles exclude from net income
(loss). For the Company, the items excluded from current net income (loss) are
cumulative foreign currency translation adjustments, unrealized gains or losses
on available-for-sale securities of affiliates, fair value adjustments on
derivative financial instruments and additional minimum pension liability
adjustments.
The components of accumulated other comprehensive income (loss) at December
31 are as follows:
2003 2002
- ------------------------------------------------------------------
Foreign currency translation $ 23,700 $ (7,500)
Unrealized gains (losses)
on securities of affiliates 300 (300)
Minimum pension liability (5,100) (5,400)
Derivative financial instruments -- (200)
- ------------------------------------------------------------------
$ 18,900 $(13,400)
==================================================================
NOTE 11: INVENTORIES
2003 2002
- ------------------------------------------------------------------
Finished goods $ 21,700 $ 18,900
Work in process 8,600 7,400
Raw materials 17,700 15,000
- ------------------------------------------------------------------
$ 48,000 $ 41,300
==================================================================
Included in the amounts above are inventories located in the United States
that are valued on the LIFO basis, amounting to $15,300 and $15,200 at December
31, 2003 and 2002, respectively, which are approximately $7,500 and $7,100,
respectively, lower than replacement value.
NOTE 12: GOODWILL AND INTANGIBLES
The Company performed its initial goodwill impairment test at January 1,
2002, and determined that no impairment of the recorded goodwill existed. The
Company has since performed an annual impairment test of its continuing
operations and determined that there is no impairment. The Company did not
record amortization expense for goodwill in 2003 and 2002 as compared to the
$1,200, net of tax, recorded in 2001.
The goodwill balance as of December 31, 2003, was $41,500 compared to $35,500
as of December 31, 2002. Foreign currency translation adjustments in the
Pharmaceutical Systems segment increased the goodwill balance $6,000 and $4,800,
respectively, as of December 31, 2003 and 2002.
In 2002, the Company recorded a $600 goodwill impairment charge, included in
discontinued operations, based on a third-party offer to purchase the Company's
consumer healthcare research business. This business, which was previously
included in the Drug Delivery Systems segment, was sold in 2002 and the
remaining goodwill balance of $1,300 was included in the disposal.
Goodwill by reportable segment as of December 31, 2003 and 2002, was as
follows:
2003 2002
- ------------------------------------------------------------------
Pharmaceutical Systems $ 39,500 $ 33,500
Drug Delivery Systems 2,000 2,000
- ------------------------------------------------------------------
$ 41,500 $ 35,500
==================================================================
The cost and respective accumulated amortization for the Company's patents
was $11,800 and $4,900, respectively, as of December 31, 2003, and $11,400 and
$4,100, respectively, as of December 31, 2002. The cost basis of patents
includes the effects of foreign currency translation adjustments. There were no
intangibles purchased or acquired during 2003 or 2002. The weighted average life
of patents purchased or acquired in 2001 was 17 years. Amortization expense for
the years ended December 31, 2003, 2002, and 2001 was $800, $800 and $600,
respectively. Estimated amortization for each of the next five years is
approximately $800 per year.
The following table reconciles the reported net income (loss) and net income
(loss) per share to that which would have resulted had the non-amortization
provisions of SFAS No. 142, "Goodwill and Other Intangible Assets," been applied
to the period ended December 31, 2001:
2001
- ------------------------------------------------------------------
As reported
Income from continuing operations $ 19,700
Discontinued operations (24,900)
- ------------------------------------------------------------------
Net (loss) income $ (5,200)
Goodwill amortization, net of tax 1,200
- ------------------------------------------------------------------
As adjusted $ (4,000)
==================================================================
As reported basic income (loss) per share
Continuing operations $ 1.38
Discontinued operations (1.74)
- ------------------------------------------------------------------
$ (.36)
- ------------------------------------------------------------------
As adjusted $ (.28)
==================================================================
As reported diluted income (loss) per share
Continuing operations $ 1.37
Discontinued operations (1.73)
- ------------------------------------------------------------------
$ (.36)
- ------------------------------------------------------------------
As adjusted $ (.28)
==================================================================
NOTE 13: PROPERTY, PLANT AND EQUIPMENT
A summary of gross property, plant and equipment at December 31 is presented
in the following table:
Years of
expected
useful life 2003 2002
- -----------------------------------------------------------------
Land $ 3,400 $ 3,000
Buildings and improvements 5-50 125,900 120,100
Machinery and equipment 2-15 332,600 301,900
Molds and dies 2-7 61,400 56,900
Construction in progress 40,300 17,700
- -----------------------------------------------------------------
$563,600 $499,600
================================================================
Construction in progress at December 31, 2003, includes $13,100 of costs
related to the rebuilding of the Kinston facility.
NOTE 14: AFFILIATED COMPANIES
At December 31, 2003, the following affiliated companies were accounted for
under the equity method:
Ownership
Location interest
- -----------------------------------------------------------------
West Pharmaceutical
Services Mexico, S.A. de C.V. Mexico 49%
Aluplast S.A. de C.V. Mexico 49%
Pharma-Tap S.A. de C.V. Mexico 49%
Daikyo Seiko, Ltd. Japan 25%
=================================================================
The Company records equity in net income (loss) of these affiliated companies
for the 12-month period ended October 31.
A summary of the financial information for these companies is presented
below:
2003 2002
- -----------------------------------------------------------------
Balance Sheets:
Current assets $ 99,600 $ 80,100
Noncurrent assets 157,500 126,200
- -----------------------------------------------------------------
Total assets $ 257,100 $ 206,300
=================================================================
Current liabilities $ 80,600 $ 62,400
Noncurrent liabilities 95,300 80,100
Owners' equity 81,200 63,800
- -----------------------------------------------------------------
Total liabilities and owners' equity $ 257,100 $ 206,300
=================================================================
2003 2002 2001
- -----------------------------------------------------------------
Income Statements:
Net sales $103,000 $ 81,800 $ 81,500
Gross profit 26,500 18,100 18,500
Net income 6,500 1,200 2,500
=================================================================
During 2002, the Company's Mexican affiliates recorded a restructuring charge
related to the consolidation of two of their rubber molding operations. Equity
in net income (loss) of affiliated companies includes $800 related to this
restructuring. All employees were terminated and all related payments were made
during 2002.
In connection with the 2002 plant consolidation, the Company advanced $1,000
to its Mexican affiliate. The note, which is denominated in U.S. dollars, is at
a 4% interest rate and is due in 2005.
Unremitted income of affiliated companies included in consolidated retained
earnings amounted to $14,200, $12,700 and $12,900 at December 31, 2003, 2002 and
2001, respectively. Dividends received from affiliated companies were $100 in
2003 and 2002 and $200 in 2001.
The Company's equity in unrealized gains and losses of Daikyo Seiko, Ltd.'s
investment in securities available for sale included in accumulated other
comprehensive income, a separate component of shareholders' equity, was $300,
$(300) and $0 at December 31, 2003, 2002 and 2001, respectively. The unrealized
gain in 2003 was net of income tax expense of $400. The unrealized losses in
2002 and 2001 are net of income tax benefits of $200 and $100, respectively.
Company purchases and royalty payments made to affiliates totaled $18,400 and
$11,500, respectively, in 2003 and 2002, of which $4,400 and $1,800 was due and
payable as of December 31, 2003 and 2002, respectively. These transactions
primarily relate to a distributorship agreement allowing the Company to purchase
and re-sell Daikyo products. Sales to affiliates were $700 and $1,000,
respectively, in 2003 and 2002, of which $200 were receivable as of December 31,
2003 and 2002.
NOTE 15: BENEFIT PLANS
The Company and certain domestic and international subsidiaries sponsor
defined benefit pension plans. In addition, the Company provides minimal life
insurance benefits for certain United States retirees and pays a portion of
healthcare (medical and dental) costs for retired United States salaried
employees and their dependents. Benefits for participants are coordinated with
Medicare and the plan mandates Medicare risk (HMO) coverage wherever possible
and caps the total contribution for non-HMO coverage.
In December 2003, the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (the Act) was signed into law. The Act introduced a
prescription drug benefit under Medicare as well as a federal subsidy to
sponsors of retiree healthcare benefit plans that provide a benefit that is at
least actuarially equivalent to Medicare. As allowed by FASB Staff Position No.
FAS 106-1, "Accounting and Disclosure Requirements Related to the Medicare
Prescription Drug, Improvement and Modernization Act of 2003" (FSP 106-1), the
Company has elected to defer accounting for the effects of the Act. In
accordance with FSP 106-1, any measures of the accumulated postretirement
benefit obligation or net periodic postretirement benefit cost in the financial
statements or accompanying notes do not reflect the effects of the Act on the
plan. Specific authoritative guidance on the accounting for the federal subsidy
is pending and that guidance, when issued, could require the sponsor to change
previously reported information. The Company does not believe the Act will have
a material impact on the Company's financial condition or results of operations.
The Company uses a December 31 measurement date for its pension and other
retirement benefit plans.
The expense (income) components of net pension expense (income) are as
follows:
Pension benefits Other retirement benefits
- --------------------------------------------------------------------------------
2003 2002 2001 2003 2002 2001
- --------------------------------------------------------------------------------
Service cost $ 4,300 $ 3,300 $ 3,500 $ 600 $ 400 $ 300
Interest cost 10,700 9,700 9,600 500 600 600
Expected return
on assets (12,300) (16,000) (19,100) -- -- --
Amortization
of unrecognized
transition asset (100) (700) (700) -- -- --
Amortization
of prior
service cost 700 600 500 (100) (1,400) (1,400)
Recognized
actuarial losses
(gains) 3,800 100 (1,900) (100) -- (100)
- --------------------------------------------------------------------------------
Pension expense
(income) $ 7,100 $ (3,000) $ (8,100) $ 900 $ (400) (600)
================================================================================
The following tables provide a reconciliation of the benefit obligation,
plan assets and funded status of the plans:
Pension benefits Other retirement benefits
- --------------------------------------------------------------------------------
2003 2002 2003 2002
- --------------------------------------------------------------------------------
CHANGE IN BENEFIT OBLIGATION:
Benefit obligation,
January 1 $(164,100) $(141,900) $(10,100) $ (8,100)
Service cost (4,300) (3,300) (600) (400)
Interest cost (10,700) (9,700) (500) (600)
Participants'
contributions (500) (300) (300) (300)
Actuarial (loss) gain (19,300) (13,300) 1,500 (900)
Amendments/
transfers in (700) (2,400) -- (500)
Benefits/expenses paid 8,000 8,800 700 700
Foreign currency
translation (2,800) (2,000) -- --
- --------------------------------------------------------------------------------
Benefit obligation,
December 31 $(194,400) $(164,100) $ (9,300) $(10,100)
================================================================================
CHANGE IN PLAN ASSETS:
Fair value of
assets, January 1 $ 142,200 $ 173,700 $ -- $ --
Actual return
on assets 32,600 (24,800) -- --
Employer
contribution 1,500 1,000 400 400
Participants'
contributions 500 300 300 300
Benefits/expenses
paid (8,000) (8,800) (700) (700)
Foreign currency
translation 1,200 800 -- --
- --------------------------------------------------------------------------------
Fair value of
plan assets,
December 31 $ 170,000 $ 142,200 $ -- $ --
================================================================================
FUNDED STATUS:
Assets less than
benefits $ (24,400) $ (21,900) $ (9,300) $(10,100)
Unrecognized net
actuarial loss (gain) 56,300 60,800 (1,600) (200)
Unrecognized
transition asset 1,500 1,200 -- --
Unrecognized
prior service cost 5,700 5,200 900 800
- --------------------------------------------------------------------------------
$ 39,100 $ 45,300 $(10,000) $ (9,500)
================================================================================
DECEMBER 31:
Pension asset $ 50,500 $ 54,700 $ -- $ --
Other long-term
liabilities (18,800) (17,200) (10,000) (9,500)
Accumulated other
comprehensive
income 7,400 7,800 -- --
- --------------------------------------------------------------------------------
$ 39,100 $ 45,300 $(10,000) $ (9,500)
================================================================================
The accumulated benefit obligation for all defined benefit pension plans was
$170,500 and $146,900 at December 31, 2003 and 2002, respectively. The pre-tax
change in the additional minimum liability included in other comprehensive
income was $(400) in 2003 and $3,400 in 2002.
The aggregate projected benefit obligation and aggregate fair value of plan
assets for pension plans with obligations in excess of plan assets were $194,400
and $170,000, respectively, as of December 31, 2003, and $164,100 and $142,200,
respectively, as of December 31, 2002. The aggregate accumulated benefit
obligation and aggregate fair value of plan assets for pension plans with
obligations in excess of plan assets were $30,100 and $11,700, respectively, as
of December 31, 2003, and $23,300 and $8,200, respectively, as of December 31,
2002.
The Company expects to contribute approximately $1,900 to pension plans and
$400 to other retirement plans in 2004.
Weighted average assumptions used to determine net periodic pension cost for
the years ended December 31 are as follows:
Pension benefits Other retirement benefits
- --------------------------------------------------------------------------
2003 2002 2001 2003 2002 2001
- --------------------------------------------------------------------------
Discount rate 6.4% 7.1% 7.6% 6.5% 7.3% 7.8%
Rate of compensation
increase 4.7% 4.6% 5.1% -- -- --
Long-term rate of
return on assets 8.8% 9.3% 9.4% -- -- --
==========================================================================
Weighted average assumptions used to determine the benefit obligations at
December 31 are as follows:
Other retirement
Pension benefits benefits
- --------------------------------------------------------------------------
2003 2002 2003 2002
- --------------------------------------------------------------------------
Discount rate 6.0% 6.4% 6.0% 6.5%
Rate of compensation increase 4.7% 4.8% -- --
==========================================================================
The long-term rate of return for U.S. plans, which account for 93% of global
plan assets, was 9% for the year ended December 31, 2003. This return assumption
was determined by reviewing the expected mix of plan assets and the projected
return over a 10-year period.
The assumed healthcare cost trend used is 12.5% for all participants in 2003,
decreasing to 5.5% by 2010. Increasing or decreasing the assumed trend rate for
healthcare costs by one percentage point would result in a $500 increase or
decrease, respectively, in the accumulated benefit obligation. The related
change in the aggregate service and interest cost components of the 2003 plan
expense would be a $100 increase or decrease, respectively.
The Company's pension plans weighted average asset allocations by asset
category for the years ended December 31 are as follows:
2003 2002
- ----------------------------------------------------------------
Equity securities 66% 71%
Debt securities 33 28
Other 1 1
- ----------------------------------------------------------------
100% 100%
================================================================
The Company's U.S. pension plan is managed as a balanced portfolio comprised
of two components: equity and fixed income debt securities. Equity investments
are used to maximize the long-term real growth of fund assets, while fixed
income investments are used to generate current income, provide for a more
stable periodic return, and to provide some protection against a prolonged
decline in the market value of fund equity investments. Temporary funds may be
held as cash. The Company maintains a long-term strategic asset allocation
policy which provides guidelines for ensuring that the fund's investments are
managed with the short-term and long-term financial goals of the fund but
provide the flexibility to allow for changes in capital markets.
The following are the Company's target asset allocations and acceptable
allocation ranges:
Target Allocation
Asset class allocation range
- --------------------------------------------------------------------
Equity 65% 55% - 75%
Debt securities 35% 25% - 45%
Cash 0% 0% - 5%
====================================================================
Diversification across and within asset classes is the primary means by which
the Company mitigates risk. The Company maintains guidelines for all asset and
sub-asset categories in order to avoid excessive investment concentrations. Fund
assets are monitored on a regular basis. If at any time the fund asset
allocation is not within the acceptable allocation range, funds will be
reallocated. The Company also reviews the fund on a regular basis to ensure that
the investment returns received are consistent with the short-term and long-term
goals of the fund and with comparable market returns.
The Company is prohibited from investing pension fund assets in the
following: the Company's own stock, securities on margin, or derivative
securities, and from pledging of securities.
The Company provides certain post-employment benefits for terminated and
disabled employees, including severance pay, disability-related benefits and
healthcare benefits. These costs are accrued over the employee's active service
period or, under certain circumstances, at the date of the event triggering the
benefit.
The Company also sponsors a defined contribution savings plan for certain
salaried and hourly United States employees. Company contributions are equal to
50% of each participant's contribution up to 6% of the participant's base
compensation. Company contributions were $1,200 in 2003, $1,100 in 2002 and
$1,300 in 2001.
NOTE 16: DEBT
Short-Term: Notes payable, which includes short-term lines of credit in the
amounts of $8,000 and $4,100 at December 31, 2003 and 2002, respectively, are
payable within one year and bear interest at a weighted average interest rate of
5.1% and 5%, respectively.
Long-Term:
At December 31, 2003 2002
- -------------------------------------------------------------------------
Unsecured:
Senior notes, due 2009 (6.81%) $ 100,000 $ 100,000
Revolving credit facility, due 2005 (1.7%) 67,000 59,200
Other notes, due 2003 (6.8% to 9.2%) -- 11,700
- -------------------------------------------------------------------------
Total long-term debt 167,000 170,900
Less current portion -- 11,700
- -------------------------------------------------------------------------
$ 167,000 $ 159,200
=========================================================================
In 1999, the Company entered into an agreement with five insurance companies
to borrow a total of $100,000 for ten years at a coupon rate of 6.81%; the
effective interest rate is 6.91%. Interest is payable quarterly.
In 2000, the Company entered into a multi-currency revolving credit
agreement. The credit agreement consisted of a $70,000, five-year revolving
credit facility and a 364-day line of credit. In July 2003, the Company
increased the 364-day line of credit to $55,000 from the $44,500 as of December
31, 2002. The total available line of credit was $125,000 and $114,500,
respectively, as of December 31, 2003 and 2002. As of December 31, 2003 and
2002, the Company had borrowed $67,000 and $59,200, respectively, under the
five-year facility. These borrowings were recorded as long-term debt. Interest
on these facilities is charged at the applicable London Inter-Bank Offering
Rates (LIBOR) plus a margin dependent on the Company's debt to total capital
ratio. Commitment fees on these credit agreements also fluctuate according to
the Company's debt to total capital ratio with a maximum commitment fee of 30
basis points on the 364-day facility and 25 basis points on the five-year
facility.
Long-term debt maturing in the years following 2003 is: $0 in 2004, $67,000
in 2005, $0 in 2006, $0 in 2007, $0 in 2008 and $100,000 thereafter.
Certain of the financing agreements, among other things, require the
maintenance of working capital, interest coverage, debt-to-capitalization and
tangible net worth ratios, and restrict the sale of assets.
Interest costs incurred during 2003, 2002 and 2001 were $10,400, $11,300 and
$14,300, respectively, of which $700, $700 and $800, respectively, were
capitalized as part of the cost of acquiring certain assets.
During 2003, the Company's remaining interest rate swap contract expired. The
swap, with a notional value of British pounds sterling (BPS) 6,950 at a fixed
interest rate of 7.23%, expired when the debt was repaid in October 2003. Under
the terms of the contract, the Company made periodic interest payments based on
the fixed rate of interest on the notional principal amount to a counterparty
that made payments based on a variable interest rate. The net interest expense
recognized in connection with these agreements was $300 in 2003, $300 in 2002
and $200 in 2001.
NOTE 17: FINANCIAL INSTRUMENTS
The following disclosure reflects the estimated fair value of financial
instruments of the Company as of December 31:
Carrying value Estimated fair
value
- ------------------------------------------------------------------
Asset (liability) 2003 2002 2003 2002
- ------------------------------------------------------------------
Cash and
cash equivalents $ 37,800 $ 33,200 $ 37,800 $ 33,200
Short- and
long-term debt (175,000) (175,000) (185,900) (175,500)
Interest rate swaps -- (200) -- (200)
Forward exchange
contracts (100) -- (100) --
==================================================================
Methods used to estimate the fair market values of the above listed financial
instruments are as follows: cash and cash equivalents, due to their short
maturity, are estimated at carrying values that approximate market; debt is
estimated based on current market quotes for instruments of similar maturity;
interest rate swaps and forward exchange rate contracts are valued at published
market prices, market prices of comparable instruments or quotes.
The Company recognizes all derivatives as either assets or liabilities and
measures those instruments at fair value as of the balance sheet date. The
change in fair value is recorded each period in earnings or other comprehensive
income depending on its hedging designation. At the adoption of the statement,
the Company recorded a charge to other comprehensive income of $200, net of tax,
to recognize the fair value of its derivative instruments.
The Company uses interest rate swaps and forward exchange contracts to
minimize the economic exposure related to fluctuating interest and foreign
exchange rates. Derivatives used by the Company are highly effective as all of
the critical terms of the derivative instruments match the hedged item.
Effectiveness is measured on a quarterly basis. The Company did not record any
amounts to the statement of income as a result of ineffectiveness for the year
ended December 31, 2003.
Unrealized gains and losses from cash flow hedges, primarily interest rate
swaps, are recorded in other comprehensive income. As the underlying transaction
occurs, any unrealized gains or losses on the related hedge are reclassified
from other comprehensive income to the statement of income (interest expense),
offsetting the income effects of the transaction to which they relate. Gains and
losses on forward exchange contracts designated as fair value hedges, primarily
related to raw material purchase commitments, are deferred and recognized in the
statement of income as part of the underlying transaction.
In October 2003, the Company's remaining interest rate swap, designated as a
cash flow hedge, expired. As a result, the $200, net of tax, which was included
in accumulated other comprehensive income as of December 31, 2002, was
reclassified from other comprehensive income to the statement of income
(interest expense).
The Company is exposed to currency fluctuations on cross-currency
intercompany loans. As a result, short-term foreign exchange contracts are used
to neutralize month-end balance sheet exposures. The forward contracts are not
designated as hedges and are recorded at fair value with any gains or losses
recognized in current period earnings in accordance with SFAS
No. 133, "Accounting for Derivative Financial Instruments and Hedging
Activities." Gains and losses on these contracts are typically offset by gains
and losses on the underlying hedged item.
In January 2003, due to continuing fluctuations in the Japanese yen, the
Company entered into an arrangement to hedge its net investment in Daikyo Seiko,
Ltd., a Japanese company in which the Company has a 25% ownership interest. The
Company's strategy was to minimize the exposure to foreign currency fluctuations
by employing borrowings in the functional currency of the investment. The
Company borrowed 1.7 billion yen under its five-year revolving credit facility
and has designated the borrowing as a hedge of its net investment in the
Company's investment in Daikyo. As of December 31, 2003, a $1,500 loss is
included in the cumulative foreign currency translation adjustment related to
this hedge.
In order to minimize the exposure to foreign currency fluctuations, the
Company borrowed 10,000 BPS in 2002 and designated the borrowing as a hedge of
the Company's net investment in its U.K. subsidiaries. Due to unfavorable
interest rates, the 10,000 BPS debt was repaid in January 2003. The
mark-to-market currency adjustments of $1,900, recorded as a cumulative
translation adjustment to shareholders' equity, will remain there until the
disposal of the investment.
NOTE 18: CAPITAL STOCK
Purchases (sales) of common stock held in treasury during the three years
ended December 31, 2003, are as follows:
2003 2002 2001
- ----------------------------------------------------------------------
Shares held,
January 1 2,684,700 2,821,300 2,854,800
Employee stock purchase plan (38,300) -- --
Purchases 500 2,900 2,400
Stock-based compensation plans (100,200) (121,400) (35,900)
Donation of shares (14,000) (18,100) --
- ----------------------------------------------------------------------
Shares held,
December 31 2,532,700 2,684,700 2,821,300
======================================================================
In 2002, the Company's Board of Directors authorized the donation of up to
40,000 shares of the Company's stock over the next three years to a related
party charitable organization. The Company donated 14,000 and 18,100 shares held
in treasury to this organization in 2003 and 2002, respectively.
In 2000, the Company established a nonqualified deferred compensation plan
for designated executive officers. Deferred amounts are invested in funds at the
executives' election. The plan requires that a portion of the deferred amount be
invested in the Company's stock. Purchases of the Company's stock by the plan
were 500, 2,900 and 2,400 in 2003, 2002 and 2001, respectively. As of December
31, 2003, there were 8,200 shares of the Company's stock held by the plan.
The Company maintains an employee stock purchase plan, which provides for the
sale of the Company's common stock to substantially all employees at a 15%
discount. The plan has two six-month offering periods per calendar year at which
time employees can enroll. Payroll deductions are limited to 25% of the
employee's base compensation. Employees may also make cash contributions to the
plan. Employees may not buy more than $25 worth of Company stock under the plan
in any one calendar year. Shares are purchased at the lower of 85% of the
Company's stock price on the last trading day before commencement of the
offering period or 85% of the Company's stock price on the last day of the
offering period. During 2003, the Company began utilizing shares held in
treasury for the purchases made by the plan. The plan expires on December 31,
2006.
NOTE 19: STOCK OPTION AND AWARD PLANS
The Company has two long-term incentive plans for officers and key management
employees of the Company and its subsidiaries. Options may no longer be granted
under one of the plans. The plans provide for the grant of stock options, stock
appreciation rights, restricted stock awards and performance awards. At December
31, 2003, there were 9,000 shares of common stock available for future grants. A
committee of the Board of Directors determines the terms and conditions of
grants, except that the exercise price of certain options cannot be less than
100% of the fair market value of the stock on the date of grant. All stock
options and stock appreciation rights are exercisable at the date indicated in
connection with their issuance, but not later than ten years after the date of
grant. Option activity is summarized in the following table:
2003 2002 2001
- ------------------------------------------------------------------------
Options outstanding,
January 1 2,027,900 1,865,200 1,667,000
Granted 395,500 316,000 360,000
Exercised (79,700) (134,600) (59,700)
Forfeited (73,500) (18,700) (102,100)
- ------------------------------------------------------------------------
Options outstanding,
December 31
2,270,200 2,027,900 1,865,200
Options exercisable,
December 31 1,520,800 1,393,900 1,020,700
========================================================================
WEIGHTED AVERAGE EXERCISE PRICE 2003 2002 2001
- ------------------------------------------------------------------------
Options outstanding,
January 1 $27.78 $27.65 $27.86
Granted 23.15 28.35 26.02
Exercised 26.66 27.20 22.26
Forfeited 30.36 28.74 28.50
- ------------------------------------------------------------------------
Options outstanding,
December 31
$26.93 $27.78 $27.65
Options exercisable,
December 31 $27.96 $28.04 $28.77
========================================================================
The range of exercise prices at December 31, 2003, was $22.59 to $32.84 per
share.
Under the Company's management incentive plan, participants are paid cash
bonuses on the attainment of certain financial goals. Bonus participants are
required to receive 25% of the value of their bonus, after certain adjustments
for taxes payable, in shares of the Company's common stock at current fair
market value. Bonus participants are given a restricted stock award equal to one
share for each four shares of common stock issued with bonus awards. The
restricted stock awards vest at the end of four years provided that the
participant has not made a disqualifying disposition of the stock purchased.
Restricted stock award grants were 4,300 shares in 2003 and 4,100 shares in
2002. There were no restricted stock awards granted in 2001.
Restricted stock forfeitures of 1,200 shares, 700 shares and 1,300 shares
occurred in 2003, 2002 and 2001, respectively. Compensation expense is
recognized over the vesting period based on the fair market value of common
stock on the award date: $19.34 per share in 2003 and $28.83 per share in 2002.
In 1999, the Company replaced its previously existing non-qualified stock
option plan for non-employee directors. The new plan made 125,000 shares
available for future grants to plan participants. Options granted under the new
plan vest over a three-year period. At December 31, 2003, 41,000 options remain
available for future grants. The Company's former plan was terminated in 1999
and no future grants will be made under that plan. There are no outstanding
options under the former plan at December 31, 2003. The exercise price on all
options is established at the market value of the Company's common stock on the
date of grant. Vesting requirements vary by option grant. Option activity under
the non-employee directors' plan(s) is summarized below:
2003 2002 2001
- ------------------------------------------------------------------
Options outstanding,
January 1 90,000 66,000 79,500
Granted 6,000 37,500 --
Exercised (300) (3,000) (6,000)
Forfeited (12,000) (10,500) (7,500)
- ------------------------------------------------------------------
Options outstanding,
December 31 83,700 90,000 66,000
Options exercisable,
December 31 52,700 52,500 52,500
==================================================================
WEIGHTED AVERAGE EXERCISE PRICE 2003 2002 2001
- ------------------------------------------------------------------
Options outstanding,
January 1 $30.50 $31.55 $30.62
Granted 23.21 27.89 --
Exercised 25.72 28.13 22.69
Forfeited 30.72 28.50 28.78
- ------------------------------------------------------------------
Options outstanding,
December 31 $29.96 $30.50 $31.55
- ------------------------------------------------------------------
Options exercisable,
December 31 $31.70 $32.36 $31.22
==================================================================
The range of exercise prices at December 31, 2003, was $23.21 to $32.84 per
share.
Stock options outstanding under all plans totaled 2,353,900 at December 31,
2003. The weighted average remaining contractual life at December 31, 2003, for
all plans is 4.6 years. The weighted average fair value per option granted in
2003, 2002 and 2001 using the Black-Scholes option-pricing model was $3.89,
$5.04 and $4.95, respectively. The following weighted average assumptions were
used to compute the fair value of the option grants in 2003, 2002 and 2001: a
risk-free interest rate of 1.9%, 3.3% and 4.4%, respectively; stock volatility
of 29.1%, 26.8% and 23.1%, respectively; and dividend yields of 3.2%, 4.4% and
3.0%, respectively. Expected lives averaged 3 years for options granted in 2003,
6 years for options granted in 2002 and 5 years for options granted in 2001
under the key management employee plan.
NOTE 20: COMMITMENTS AND CONTINGENCIES
At December 31, 2003, the Company was obligated under various operating lease
agreements with terms ranging from one month to 20 years. Net rental expense in
2003, 2002 and 2001 was $6,700, $6,500 and $6,300, respectively, and is net of
sublease income of $700, $600, and $600, respectively.
At December 31, 2003, future minimum rental payments under non-cancelable
operating leases were:
- -----------------------------------------------------------------
2004 $ 7,200
2005 6,900
2006 6,200
2007 6,000
2008 6,400
Thereafter 25,100
- -----------------------------------------------------------------
Total 57,800
Less sublease income 2,600
- -----------------------------------------------------------------
$ 55,200
=================================================================
At December 31, 2003, outstanding unconditional contractual commitments for
the purchase of equipment and raw materials amounted to $2,800, all of which is
due to be paid in 2004.
Pursuant to applicable state programs, the Company is currently completing
environmental remediation activities at one current and three former
manufacturing facilities. The Company has reserved a total of $1,000 to address
the cost of remediation at these facilities. The Company has not anticipated any
possible recovery from insurance or other sources. Neither collectively nor
individually do these remediation projects present material impacts to the
Company's operating budgets, profits or competitive position.
The facilities being addressed are as follows: 1) former Technical Center
facility in Phoenixville, Pa.; 2) former plastics manufacturing facility in
Wayne, N.J.; 3) current operating plant in St. Petersburg, Fla.; and 4) former
Kinston, N.C., facility, which was destroyed by fire in January 2003. Although
the Company cannot be certain, the Company expects that remediation activities
at all of these facilities will be completed in 2004, with the exception of
periodic groundwater compliance monitoring activities.
In July 2003, the Company signed an Administrative Order on Consent with the
U.S. Environmental Protection Agency (EPA) requiring the Company to complete
certain site assessment and cleanup activities following the explosion and fire
at its Kinston, N.C., facility. As part of that agreement, the Company also
reimbursed the EPA's past response costs of $300, and agreed to reimburse the
future oversight costs associated with the on-going site assessment and cleanup.
At December 31, 2003, the Company had outstanding letters of credit of $500.
The letters of credit act as a guarantee of payment to certain third parties in
accordance with specified terms and conditions.
The Company has been named a defendant in a lawsuit filed in connection with
the explosion and related fire in which plaintiffs seek unspecified compensatory
and punitive damages. Because this lawsuit is in its early stages, the Company
is unable to estimate these plaintiffs' alleged damages. The Company believes
that overall it has sufficient insurance to cover losses from expected
litigation associated with the incident.
NOTE 21: NEW ACCOUNTING STANDARDS
In December 2003, the Financial Accounting Standards Board ("FASB") released
SFAS No. 132 (revised 2003), "Employer's Disclosures about Pensions and Other
Postretirement Benefits." This statement revises employers' disclosures about
pension plans and other postretirement benefit plans by expanding disclosures
for assets, obligations, cash flows, and net periodic benefit cost of defined
benefit pension plans and other defined benefit postretirement plans. The
statement is effective, except as noted, for fiscal years ending after December
15, 2003. Certain disclosures about foreign plans and benefit payments are
required for fiscal years ending after June 15, 2004. The Company adopted
revised SFAS No. 132 in December 2003 and has therefore included the disclosures
required by the statement, except the disclosures for benefits, which will be
included after June 15, 2004.
In December 2003, the FASB released Interpretation No. 46 (revised December
2003), "Consolidation of Variable Interest Entities, an Interpretation of
Accounting Research Bulletin No. 51" (FIN 46R). FIN 46R requires a company to
consolidate a variable interest entity if the equity investment at risk is not
sufficient to permit the entity to finance its activities without additional
financial support, or if the equity investors lack the essential characteristics
of a controlling financial interest, or if the equity investors have voting
rights that are not proportionate to their economic interests and the activities
of the entity involve or are conducted on behalf of an investor. FIN 46R is
effective for entities that have interests in structures referred to as special
purpose entities for periods ending after December 15, 2003. Application for all
other types of variable interest entities is required in financial statements
for periods ending after March, 15, 2004. FIN 46R will not have a material
effect on the Company's consolidated financial position or results of
operations.
In November 2002, the Emerging Issues Task Force ("EITF") reached a consensus
opinion on EITF 00-21, "Revenue Arrangements with Multiple Deliverables." The
consensus provides guidance on accounting by a vendor for arrangements under
which it will perform multiple revenue-generating activities. Specifically, the
consensus addresses how to determine whether an arrangement involving multiple
deliverables contains more than one unit of accounting. EITF 00-21 is effective
for revenue arrangements entered into in fiscal periods beginning after June 15,
2003. EITF 00-21 did not have a material effect on the Company's consolidated
financial position or results of operations.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS No. 146 requires that a liability for
costs associated with a disposal activity, including those related to employee
termination benefits, be recognized when the liability is incurred, and not
necessarily at the date of an entity's commitment to an exit plan as had been
the practice under the prior accounting guidance. The Company adopted SFAS No.
146 on January 1, 2003.
In 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations," which addresses financial accounting and reporting obligations
associated with the retirement of long-lived assets that result from the
acquisition, construction, development or normal use of the asset. The Company
adopted SFAS No. 143 on January 1, 2003. SFAS No. 143 did not have a material
impact on the Company's financial position or results of operation.
REPORT OF MANAGEMENT
The Company's management is responsible for the integrity, reliability and
objectivity of publicly reported financial information. Management believes that
the financial statements as of and for the year ended December 31, 2003, have
been prepared in conformity with accounting principles generally accepted in the
United States of America and that information presented in this Annual Report is
consistent with those statements. In preparing the financial statements,
management makes informed judgments and estimates where necessary, with
appropriate consideration given to materiality.
In meeting its responsibility for preparing financial statements, management
maintains a system of internal accounting controls to assure the safety of its
assets against unauthorized acquisition, use or disposition. This system is
designed to provide reasonable assurance that assets are safeguarded and
transactions are recorded properly and executed in accordance with management's
authorization, allowing for preparation of reliable financial statements. There
are inherent limitations in the effectiveness of all internal control systems.
The design of the Company's system recognizes that errors or irregularities may
occur and that estimates and judgments are required to assess the relative cost
and expected benefits of the controls. Management believes the Company's
accounting controls provide reasonable assurance that errors or irregularities
that could be material to the financial statements are prevented or would be
detected within a timely period.
The independent accountants are appointed by the Audit Committee of the
Board of Directors, with the approval of the shareholders. As part of their
engagement, the independent accountants audit the Company's financial
statements, express their opinion thereon, and review and evaluate selected
systems, accounting procedures and internal controls to the extent they consider
necessary to support their report.
/s/ Donald E. Morel, Jr., Ph.D.
- -----------------------------------------------
Donald E. Morel, Jr., Ph.D.
Chairman, President and Chief Executive Officer
/s/ William J. Federici
- -----------------------------------------------
William J. Federici
Vice President and Chief Financial Officer
REPORT OF INDEPENDENT AUDITORS
To the Shareholders and the Board of Directors of
West Pharmaceutical Services, Inc.:
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of income, of comprehensive income, of
shareholders' equity and of cash flows present fairly, in all material respects,
the financial position of West Pharmaceutical Services, Inc. and its
subsidiaries at December 31, 2003 and 2002, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 2003, in conformity with accounting principles generally accepted in the
United States of America. These financial statements are the responsibility of
the Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with auditing standards generally accepted in the
United States of America, which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
As discussed in Note 12 to the Consolidated Financial Statements, the
Company changed the manner in which it accounts for goodwill and other
intangible assets as of January 1, 2002.
/s/ PricewaterhouseCoopers LLP
- ------------------------------
PricewaterhouseCoopers LLP
Philadelphia, Pennsylvania
February 17, 2004
FIVE-YEAR SUMMARY
West Pharmaceutical Services, Inc. and Subsidiaries
(in thousands of dollars, except per share data) 2003 2002 2001 2000 1999
- ------------------------------------------------------------------------------------------------------------------------------------
SUMMARY OF OPERATIONS
Net sales $ 490,700 419,700 392,300 372,500 390,200
Operating profit $ 54,500 26,700 39,900 40,200 60,300
Income from continuing operations $ 31,900 12,800 19,700 20,000 36,400
Income (loss) from discontinued operations $ -- 5,600 (24,900) (18,400) 2,300
- -----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 31,900 18,400 (5,200) 1,600 38,700
- -----------------------------------------------------------------------------------------------------------------------------------
Income per share from continuing operations:
Basic (a) $ 2.20 .89 1.38 1.39 2.44
Assuming dilution (b) $ 2.19 .89 1.37 1.39 2.42
Income (loss) per share from discontinued operations:
Basic (a) $ -- .39 (1.74) (1.28) .15
Assuming dilution (b) $ -- .39 (1.73) (1.28) .15
Average common shares outstanding 14,513 14,434 14,336 14,407 14,914
Average shares assuming dilution 14,546 14,434 14,348 14,409 15,048
Dividends paid per common share $ .81 .77 .73 .69 .65
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Research and development expenses $ 18,700 16,400 13,000 10,900 9,300
Capital expenditures $ 60,800 37,700 45,200 47,700 39,300
===================================================================================================================================
YEAR-END FINANCIAL POSITION
Working capital $ 97,800 73,600 83,200 93,800 80,700
Total assets $ 623,600 529,600 508,200 554,100 549,600
Total invested capital:
Total debt $ 175,000 175,000 193,000 199,400 171,100
Minority interests $ -- -- -- 1,000 800
Shareholders' equity $ 257,600 201,500 176,800 204,800 231,200
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Total invested capital $ 432,600 376,500 369,800 405,200 403,100
===================================================================================================================================
PERFORMANCE MEASUREMENTS
Gross margin (c) % 31.8 28.0 29.3 28.9 33.9
Operating profitability (d) % 11.1 6.4 10.2 10.8 15.5
Effective tax rate % 35.6 24.0 30.7 34.7 31.4
Asset turnover ratio (e) .85 .81 .74 .68 .74
Return on average shareholders' equity % 13.9 9.8 (2.7) .7 16.8
Total debt as a percentage of total invested capital % 40.5 46.5 52.2 49.2 42.5
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Stock price range $ 35.80 - 16.65 32.50 - 16.25 28.35 - 22.75 31.88 - 19.63 40.44 - 30.88
===================================================================================================================================
Performance measurements represent indicators commonly used in the financial
community. They are not measures of financial performance under generally
accepted accounting principles.
(a) Based on average common shares outstanding.
(b) Based on average shares, assuming dilution.
(c) Net sales minus cost of goods sold, including applicable depreciation and
amortization, divided by net sales.
(d) Operating profit divided by net sales.
(e) Net sales divided by average total assets.
o 2003 includes a net gain from an insurance settlement of $12.1 million (net
of tax) and includes asset impairment and post-employment benefit charges
that reduced operating results by $7.5 million (including a related tax
charge).
o 2002 includes a net restructuring charge of $7.4 million (net of tax), tax
benefits of $2.4 million resulting from a change in tax law, a $0.8 million
charge related to the restructuring of one of the Company's affiliates and a
foreign currency exchange gain of $0.8 million (net of tax).
o 2001 includes a net restructuring charge that reduced operating results by
$1.3 million (net of tax).
o 2000 includes tax benefits totaling $1.5 million realized upon the
favorable resolution of tax issues connected to the 1997 reorganization of
the Company's German subsidiaries, and includes a restructuring charge that
reduced operating results by $4.9 million (net of tax).
o 1999 includes net tax benefits totaling $2.3 million related to a favorable
determination of a prior years' tax appeal and the refund of taxes paid
previously as a result of a dividend, and includes for the first time
results of the clinical service business acquired on April 20, 1999.
QUARTERLY OPERATING AND PER SHARE DATA (UNAUDITED)
West Pharmaceutical Services, Inc. and Subsidiaries
First Second Third Fourth Full
(in thousands of dollars, except per share data) Quarter Quarter Quarter Quarter Year
- --------------------------------------------------------------------------------------------------------------------------------
2003
- ----
Net sales $117,800 $126,400 $120,100 $126,400 $490,700
Gross profit 36,400 41,400 35,800 42,200 155,800
- --------------------------------------------------------------------------------------------------------------------------------
Net income 3,800 6,900 4,100 17,100 31,900
- --------------------------------------------------------------------------------------------------------------------------------
Basic earnings per share
Continuing operations .26 .48 .28 1.17 2.20
Diluted earnings per share
Continuing operations .26 .48 .28 1.14 2.19
2002
- ----
Net sales $101,700 $106,500 $104,100 $107,400 $419,700
Gross profit 30,800 30,700 26,300 29,800 117,600
Income (loss) from continuing operations 6,300 5,200 (2,000) 3,300 12,800
Discontinued operations, net (200) 100 5,600 100 5,600
- --------------------------------------------------------------------------------------------------------------------------------
Net income 6,100 5,300 3,600 3,400 18,400
- --------------------------------------------------------------------------------------------------------------------------------
Basic earnings (loss) per share
Continuing operations .44 .36 (.14) .23 .89
Discontinued operations (.02) .01 .39 .01 .39
- --------------------------------------------------------------------------------------------------------------------------------
.42 .37 .25 .24 1.28
Diluted earnings (loss) per share
Continuing operations .44 .36 (.14) .23 .89
Discontinued operations (.02) .01 .39 .01 .39
- --------------------------------------------------------------------------------------------------------------------------------
.42 .37 .25 .24 1.28
================================================================================================================================
Per common share amounts for the quarters and full years have each been
calculated separately. Accordingly, quarterly amounts may not add to the full
year amounts because of differences in the average common shares outstanding
during each period and, with regard to diluted per common share amounts only,
because of the inclusion of the effect of potentially dilutive securities only
in the periods in which such effect would have been dilutive.
o Full year 2003 results include costs associated with the Kinston plant
explosion. See Note "Kinston."
o Fourth quarter 2003 results include the effect of the gain from the insurance
settlement from the Kinston plant explosion. See Note "Kinston."
o Fourth quarter 2003 results include the effect of the impairment of the
Company's plastics device plant. See Note "Restructuring and Impairment
Charges."
o First quarter 2002 results include a foreign currency exchange gain. See
Note "Other Income (Expense)."
o Third quarter 2002 results include the write-off of the Company's
information systems implementation project, the write-down of an
investment, the tax benefit resulting from a change in tax law, and the
restructuring of one of the Company's affiliates. See Notes "Restructuring
and Impairment Charges," "Income Taxes" and "Affiliated Companies."
o Fourth quarter 2002 results include severance provisions primarily
associated with the termination of the information systems implementation
project. See Note "Restructuring and Impairment Charges."
First Quarter Second Quarter Third Quarter Fourth Quarter Year
- ------------------------------------------------------------------------------------------------------------------------------
STOCK PRICE High Low Close High Low Close High Low Close High Low Close High Low Close
- ------------------------------------------------------------------------------------------------------------------------------
2003 $24.87 $16.65 $19.60 $26.16 $19.90 $24.50 $34.75 $23.20 $31.31 $35.80 $30.90 $33.90 $35.80 $16.65 $33.90
2002 30.53 25.00 30.35 32.50 27.90 32.09 31.99 21.08 21.42 24.80 16.25 24.40 32.50 16.25 24.40
2001 26.16 22.75 23.35 27.60 22.80 27.00 28.35 23.12 24.60 28.30 23.30 26.60 28.35 22.75 26.60
==============================================================================================================================
Close is the last trading day of the quarter or the year.
DIVIDENDS PAID PER SHARE First Quarter Second Quarter Third Quarter Fourth Quarter Year
- ------------------------------------------------------------------------------------------------------------------------------
2003 $.20 $.20 $.20 $.21 $.81
2002 .19 .19 .19 .20 .77
2001 .18 .18 .18 .19 .73
==============================================================================================================================