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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-Q
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2019
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from            to

Commission File Number 1-8036

WEST PHARMACEUTICAL SERVICES, INC.
(Exact name of registrant as specified in its charter)
 
Pennsylvania
 
 
23-1210010
 
 (State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification Number)
 
 
 
 
 
 
 
 
 
 
530 Herman O. West Drive,
Exton,
PA
 
 
19341-0645
 
 
(Address of principal executive offices)
 
 
(Zip Code)
 

Registrant’s telephone number, including area code: 610-594-2900
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol
Name of each exchange on which registered
Common Stock, par value $0.25 per share
WST
New York Stock Exchange
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.          Yes No 
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).                      Yes  No 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
Accelerated filer
Non-accelerated filer
 
Smaller reporting company
 
 
 
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.                                                     
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes  No 
As of September 30, 2019, there were 73,990,675 shares of the registrant’s common stock outstanding.


Table of Contents

TABLE OF CONTENTS

 
 
Page
 
FINANCIAL STATEMENTS (UNAUDITED)
 
 
 
 
 
 
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
CONTROLS AND PROCEDURES
 
 
 
 
LEGAL PROCEEDINGS
RISK FACTORS
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
EXHIBITS
 
 
 
 
 
 
 
 

2

Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1.   FINANCIAL STATEMENTS

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
West Pharmaceutical Services, Inc. and Subsidiaries
(in millions, except per share data)


 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2019
 
2018
 
2019
 
2018
Net sales
$
456.1

 
$
431.7

 
$
1,369.3

 
$
1,294.9

Cost of goods and services sold
308.3

 
296.1

 
916.8

 
882.7

Gross profit
147.8

 
135.6

 
452.5

 
412.2

Research and development
9.3

 
10.1

 
28.7

 
30.5

Selling, general and administrative expenses
64.8

 
64.9

 
203.7

 
203.2

Other expense (income) (Note 15)
6.4

 
(0.2
)
 
1.6

 
4.0

Operating profit
67.3

 
60.8

 
218.5

 
174.5

Interest expense
2.1

 
2.0

 
6.4

 
6.1

Interest income
(1.0
)
 
(0.5
)
 
(2.5
)
 
(1.4
)
Other nonoperating expense (income)
1.3

 
(1.8
)
 
0.2

 
(5.1
)
Income before income taxes
64.9

 
61.1

 
214.4

 
174.9

Income tax expense
10.9

 
8.0

 
42.5

 
26.5

Equity in net income of affiliated companies
(2.3
)
 
(2.1
)
 
(5.9
)
 
(6.5
)
Net income
$
56.3

 
$
55.2

 
$
177.8

 
$
154.9

 
 
 
 
 
 
 
 
Net income per share:
 
 
 

 
 

 
 

Basic
$
0.76

 
$
0.75

 
$
2.40

 
$
2.10

Diluted
$
0.75

 
$
0.73

 
$
2.36

 
$
2.05

 
 
 
 
 
 
 
 
Weighted average shares outstanding:
 

 
 

 
 

 
 

Basic
74.0

 
73.9

 
73.9

 
73.9

Diluted
75.5

 
75.7

 
75.3

 
75.4


See accompanying notes to condensed consolidated financial statements.

3

Table of Contents

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

 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2019
 
2018
 
2019
 
2018
Net income
$
56.3

 
$
55.2

 
$
177.8

 
$
154.9

Other comprehensive (loss) income, net of tax:
 

 
 
 
 

 
 

Foreign currency translation adjustments
(23.8
)
 
(9.5
)
 
(20.1
)
 
(39.1
)
Defined benefit pension and other postretirement plan adjustments, net of tax of $0.7, $0, $0.7 and $0.1, respectively
2.4

 
(0.2
)
 
2.2

 
0.1

Net gain (loss) on derivatives, net of tax of $1.5, $(0.1), $0.7, and $1.0, respectively
3.2

 
(0.4
)
 
1.7

 
2.5

Other comprehensive loss, net of tax
(18.2
)
 
(10.1
)
 
(16.2
)
 
(36.5
)
Comprehensive income
$
38.1

 
$
45.1

 
$
161.6

 
$
118.4


See accompanying notes to condensed consolidated financial statements.

4

Table of Contents

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
West Pharmaceutical Services, Inc. and Subsidiaries
(in millions, except per share data)
 
September 30,
2019
 
December 31,
2018
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
396.0

 
$
337.4

Accounts receivable, net
316.1

 
288.2

Inventories
230.4

 
214.5

Other current assets
61.6

 
54.3

Total current assets
1,004.1

 
894.4

Property, plant and equipment
1,779.8

 
1,752.7

Less: accumulated depreciation and amortization
967.7

 
930.7

Property, plant and equipment, net
812.1

 
822.0

Operating lease right-of-use assets
71.3

 

Investments in affiliated companies
97.4

 
91.2

Goodwill
106.6

 
105.8

Deferred income taxes
33.8

 
24.7

Intangible assets, net
28.7

 
20.3

Other noncurrent assets
20.0

 
20.5

Total Assets
$
2,174.0

 
$
1,978.9

 
 
 
 
LIABILITIES AND EQUITY
 

 
 

Current liabilities:
 

 
 

Notes payable and other current debt
$

 
$
0.1

Accounts payable
145.3

 
130.4

Pension and other postretirement benefits
2.2

 
2.3

Accrued salaries, wages and benefits
72.6

 
64.5

Income taxes payable
19.1

 
9.8

Operating lease liabilities
9.8

 

Other current liabilities
86.0

 
76.6

Total current liabilities
335.0

 
283.7

Long-term debt
195.1

 
196.0

Deferred income taxes
10.3

 
13.1

Pension and other postretirement benefits
46.8

 
56.2

Operating lease liabilities
63.5

 

Other long-term liabilities
35.7

 
33.6

Total Liabilities
686.4

 
582.6

 
 
 
 
Commitments and contingencies (Note 17)


 


 
 
 
 
Equity:
 
 
 
Preferred stock, 3.0 million shares authorized; 0 shares issued and outstanding

 

Common stock, par value $0.25 per share; 100.0 million shares authorized; shares issued: 75.3 million and 75.3 million; shares outstanding: 74.0 million and 74.1 million
18.8

 
18.8

Capital in excess of par value
268.5

 
282.0

Retained earnings
1,497.3

 
1,353.4

Accumulated other comprehensive loss
(170.4
)
 
(154.2
)
Treasury stock, at cost (1.3 million and 1.2 million shares)
(126.6
)
 
(103.7
)
Total Equity
1,487.6

 
1,396.3

Total Liabilities and Equity
$
2,174.0

 
$
1,978.9


See accompanying notes to condensed consolidated financial statements.

5

Table of Contents

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
West Pharmaceutical Services, Inc. and Subsidiaries
(in millions)
 
Nine Months Ended
September 30,
 
2019
 
2018
Cash flows from operating activities:
 
 
 
Net income
$
177.8

 
$
154.9

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation
74.6

 
76.1

Amortization
2.5

 
2.0

Stock-based compensation
18.8

 
14.7

Non-cash restructuring charges
1.6

 
0.8

Pension settlement charge
2.7

 

Contingent consideration payments in excess of acquisition-date liability
(0.3
)
 
(0.5
)
Other non-cash items, net
(0.6
)
 
(4.0
)
Changes in assets and liabilities
(16.3
)
 
(28.6
)
Net cash provided by operating activities
260.8

 
215.4

 
 
 
 
Cash flows from investing activities:
 

 
 

Capital expenditures
(88.8
)
 
(74.7
)
Acquisition of business
(18.9
)
 

Other, net
0.3

 
2.5

Net cash used in investing activities
(107.4
)
 
(72.2
)
 
 
 
 
Cash flows from financing activities:
 

 
 

Borrowings under revolving credit agreements
28.0

 

Repayments under revolving credit agreements
(28.0
)
 

Debt issuance costs
(0.9
)
 

Dividend payments
(33.3
)
 
(31.0
)
Proceeds from stock-based compensation awards
25.5

 
25.7

Employee stock purchase plan contributions
4.0

 
3.6

Shares purchased under share repurchase programs
(83.1
)
 
(70.8
)
Net cash used in financing activities
(87.8
)
 
(72.5
)
Effect of exchange rates on cash
(7.0
)
 
(9.3
)
Net increase in cash and cash equivalents
58.6

 
61.4

 
 
 
 
Cash, including cash equivalents at beginning of period
337.4

 
235.9

Cash, including cash equivalents at end of period
$
396.0

 
$
297.3


See accompanying notes to condensed consolidated financial statements.

6

Table of Contents

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 1:  Summary of Significant Accounting Policies

Basis of Presentation: The condensed consolidated financial statements included in this report are unaudited and have been prepared in accordance with United States (“U.S.”) generally accepted accounting principles (“U.S. GAAP”) for interim financial reporting and U.S. Securities and Exchange Commission (“SEC”) regulations. The year-end condensed consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by U.S. GAAP. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with U.S. GAAP have been condensed or omitted. In the opinion of management, these financial statements include all adjustments, which are of a normal recurring nature, necessary for a fair statement of the financial position, results of operations, cash flows and the change in equity for the periods presented. The condensed consolidated financial statements for the three and nine months ended September 30, 2019 should be read in conjunction with the consolidated financial statements and notes thereto of West Pharmaceutical Services, Inc. and its majority-owned subsidiaries (which may be referred to as “West”, the “Company”, “we”, “us” or “our”) appearing in our Annual Report on Form 10-K for the year ended December 31, 2018 (the “2018 Annual Report”). The results of operations for any interim period are not necessarily indicative of results for the full year.

In April 2019, we acquired the business of our distributor in South Korea for $18.9 million. As a result of the acquisition, we recorded inventories, property, plant and equipment, goodwill and a customer relationships intangible asset of $4.5 million, $0.6 million, $2.6 million and $11.2 million, respectively. The goodwill was recorded within our Proprietary Products reportable segment. The results of this acquisition have been included in our condensed consolidated financial statements since the acquisition date.

As of April 1, 2017, our consolidated financial statements exclude the results of our Venezuelan subsidiary. Please refer to Note 15, Other Expense, to the consolidated financial statements in our 2018 Annual Report for further discussion.

Note 2:  New Accounting Standards

Recently Adopted Standards

In August 2018, the SEC adopted a final release which would eliminate or modify certain disclosure requirements that are redundant, outdated, or duplicative of U.S. GAAP or other regulatory requirements. Among other changes, the amendments provide that disclosure requirements related to the analysis of shareholders’ equity are expanded for interim purposes. An analysis of the changes in each caption of shareholders’ equity presented in the balance sheet must be provided in a note or separate statement, as well as the amount of dividends per share for each class of shares. We provided this disclosure beginning in the first quarter of 2019. Please refer to Note 12, Shareholders Equity.

In June 2018, the Financial Accounting Standards Board (“FASB”) issued guidance which expands the scope of accounting for share-based payment arrangements to include share-based payment transactions for acquiring goods and services from nonemployees. This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018. Early adoption was permitted. We adopted this guidance as of January 1, 2019, on a prospective basis. The adoption did not have a material impact on our financial statements.

In February 2018, the FASB issued guidance to address a specific consequence of the Tax Cuts and Jobs Acts (the “2017 Tax Act”) by allowing a reclassification from accumulated other comprehensive income (loss) to retained earnings for stranded tax effects resulting from the 2017 Tax Act’s reduction of the U.S. federal corporate income tax rate. This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018. Early adoption was permitted. We adopted this guidance as of January 1, 2019, on a prospective basis, but elected to not reclassify from accumulated other comprehensive income (loss) to retained earnings the stranded tax effects resulting from the 2017 Tax Act’s reduction of the U.S. federal corporate income tax rate.

7

Table of Contents


In August 2017, the FASB issued guidance which expands and refines hedge accounting for both nonfinancial and financial risk components and aligns the recognition and presentation of the effects of the hedging instrument and the hedged item in the financial statements. This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018. Early adoption was permitted. We adopted this guidance as of January 1, 2019, on a prospective basis. The adoption did not have a material impact on our financial statements.

In February 2016, the FASB issued guidance on the accounting for leases, Accounting Standards Codification (“ASC”) Topic 842 (“ASC 842”). This guidance requires lessees to recognize lease assets and lease liabilities on the balance sheet and to expand disclosures about leasing arrangements, both qualitative and quantitative. In terms of transition, the guidance requires adoption based upon a modified retrospective approach. This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018. Early adoption was permitted. We adopted this guidance as of January 1, 2019, using the modified retrospective approach that allows companies to apply ASC 842 as of the effective date and on a prospective basis. Please refer to Note 6, Leases, for additional information.

Standards Issued Not Yet Adopted

In April 2019, the FASB issued guidance which clarifies and improves areas of guidance related to the new credit losses, hedging, and recognition and measurement standards. This guidance is effective for the same fiscal years in which the original standards are effective or, if already implemented, annual periods beginning after the issuance of this guidance. Early adoption is permitted. We believe that the adoption of this guidance will not have a material impact on our financial statements.

In August 2018, the FASB issued guidance to align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). The accounting for the service element of a hosting arrangement that is a service contract is not affected by this update. This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2019. Early adoption is permitted, including adoption in any interim period. We believe that the adoption of this guidance will not have a material impact on our financial statements.

In August 2018, the FASB issued guidance which modifies the disclosure requirements for defined benefit pension plans and other postretirement plans. The guidance removes disclosures that no longer are considered cost beneficial, clarifies the specific requirements of disclosures, and adds disclosure requirements identified as relevant. This guidance is effective for fiscal years ending after December 15, 2020. Early adoption is permitted. We believe that the adoption of this guidance will not have a material impact on our financial statements.

In August 2018, the FASB issued guidance which modifies the disclosure requirements on fair value measurements by removing, modifying, or adding certain disclosures. This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2019. Early adoption is permitted. We believe that the adoption of this guidance will not have a material impact on our financial statements.

In June 2016, the FASB issued guidance which provides financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments held by a reporting entity at each reporting date. This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2019. Early adoption is permitted. We believe that the adoption of this guidance will not have a material impact on our financial statements.


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Note 3:  Revenue

The following table presents the approximate percentage of our net sales by market group:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2019
 
2018
 
2019
 
2018
Biologics
26
%
 
21
%
 
25
%
 
21
%
Generics
20
%
 
21
%
 
20
%
 
21
%
Pharma
30
%
 
34
%
 
31
%
 
35
%
Contract-Manufactured Products
24
%
 
24
%
 
24
%
 
23
%
 
100
%
 
100
%
 
100
%
 
100
%
The following table presents the approximate percentage of our net sales by product category:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2019
 
2018
 
2019
 
2018
High-Value Components
42
%
 
41
%
 
43
%
 
42
%
Standard Packaging
28
%
 
31
%
 
29
%
 
32
%
Delivery Devices
6
%
 
4
%
 
4
%
 
3
%
Contract-Manufactured Products
24
%
 
24
%
 
24
%
 
23
%
 
100
%
 
100
%
 
100
%
 
100
%
The following table presents the approximate percentage of our net sales by geographic location:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2019
 
2018
 
2019
 
2018
Americas
48
%
 
51
%
 
48
%
 
48
%
Europe, Middle East, Africa
44
%
 
41
%
 
44
%
 
44
%
Asia Pacific
8
%
 
8
%
 
8
%
 
8
%
 
100
%
 
100
%
 
100
%
 
100
%

Contract Assets and Liabilities
The following table summarizes our contract assets and liabilities, excluding contract assets included in accounts receivable, net:
 
($ in millions)
Contract assets, December 31, 2018
$
9.1

Contract assets, September 30, 2019
9.4

Change in contract assets - increase (decrease)
$
0.3

 
 
Deferred income, December 31, 2018
$
(33.4
)
Deferred income, September 30, 2019
(30.9
)
Change in deferred income - decrease (increase)
$
2.5



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The decrease in deferred income during the nine months ended September 30, 2019 was primarily due to the recognition of revenue of $79.3 million, including $18.0 million of revenue that was included in deferred income at the beginning of the year, and $2.7 million in other adjustments, partially offset by additional cash payments of $79.5 million received in advance of satisfying future performance obligations.
The majority of the performance obligations within our contracts are satisfied within one year or less. Performance obligations satisfied beyond one year include those relating to a nonrefundable customer payment of $20.0 million received in June 2013 in return for the exclusive use of the SmartDose® technology platform within a specific therapeutic area. As of September 30, 2019, there was $5.9 million of unearned income related to this payment, of which $0.9 million was included in other current liabilities and $5.0 million was included in other long-term liabilities. The unearned income is being recognized as income on a straight-line basis over the remaining term of the agreement. The agreement does not include a future minimum purchase commitment from the customer.
Supply Chain Financing
We have entered into supply chain financing agreements with certain banks, pursuant to which we offer for sale certain accounts receivable to such banks from time to time, subject to the terms of the applicable agreements. These transactions result in a reduction in accounts receivable, as the agreements transfer effective control over, and credit risk related to, the receivables to the banks. These agreements do not allow for recourse in the event of uncollectibility, and we do not retain any interest in the underlying accounts receivable once sold. As of September 30, 2019, we derecognized $7.9 million of accounts receivable under these agreements. Discount fees related to the sale of such accounts receivable on our condensed consolidated income statements for the nine months ended September 30, 2019 were not material.

Voluntary Recall
On January 24, 2019, we issued a voluntary recall of our Vial2Bag® product line due to reports of potential unpredictable or variable dosing under certain conditions. Our fourth quarter 2018 results included an $11.3 million provision for product returns, recorded as a reduction of sales, partially offset by a reduction in cost of goods sold reflecting our inventory balance for these devices at December 31, 2018. During the three and nine months ended September 30, 2019, we recorded a net adjustment of $0.9 million and a net provision of $4.9 million, respectively, for potential inventory returns from our customers and related in-house inventory, partially offset by a reduction in our provision for product returns. We continue to work to get the products back on the market.

Note 4:  Net Income Per Share

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

 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
(in millions)
2019
 
2018
 
2019
 
2018
Net income
$
56.3

 
$
55.2

 
$
177.8

 
$
154.9

Weighted average common shares outstanding
74.0

 
73.9

 
73.9

 
73.9

Dilutive effect of equity awards, based on the treasury stock method
1.5

 
1.8

 
1.4

 
1.5

Weighted average shares assuming dilution
75.5

 
75.7

 
75.3

 
75.4



During the three months ended September 30, 2019 and 2018, there were 0.1 million and 0.1 million shares, respectively, from stock-based compensation plans not included in the computation of diluted net income per share because their impact was antidilutive. There were 0.3 million and 0.4 million antidilutive shares outstanding during the nine months ended September 30, 2019 and 2018, respectively.


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In February 2019, we announced a share repurchase program for calendar-year 2019 authorizing the repurchase of up to 800,000 shares of our common stock from time to time on the open market or in privately-negotiated transactions as permitted under the Securities Exchange Act of 1934 Rule 10b-18. The number of shares repurchased and the timing of such transactions depended on a variety of factors, including market conditions. There were no shares purchased during the three months ended September 30, 2019. During the nine months ended September 30, 2019, we purchased 800,000 shares of our common stock under the now-completed program at a cost of $83.1 million, or an average price of $103.89 per share.

Note 5:  Inventories

Inventories are valued at the lower of cost (on a first-in, first-out basis) and net realizable value. Inventory balances were as follows:

($ in millions)
September 30,
2019
 
December 31,
2018
Raw materials
$
99.2

 
$
90.4

Work in process
38.3

 
42.2

Finished goods
92.9

 
81.9

 
$
230.4

 
$
214.5



Note 6:  Leases

Adoption of ASC 842

On January 1, 2019, we adopted ASC 842, using the modified retrospective approach that allows companies to apply ASC 842 as of the effective date and on a prospective basis. As a result, we were not required to adjust our comparative period financial information for effects of ASC 842 or present the new required lease disclosures for periods prior to the date of adoption. As of September 30, 2019, we had operating leases primarily related to land, buildings, and machinery and equipment, with lease terms through 2047. Certain of our operating leases include options to extend the lease term for up to five years, and certain of our operating leases include options to terminate the leases within one year. We had no finance leases as of September 30, 2019.

As a result of our adoption of ASC 842, we recorded operating lease right-of-use assets of $71.0 million and operating lease liabilities of $73.1 million for operating leases where we are the lessee in our condensed consolidated balance sheet as of January 1, 2019. The operating lease right-of-use assets are initially measured at cost, which comprises the initial amount of the lease liability adjusted for lease payments made at or before the lease commencement date, plus any initial direct costs incurred less any lease incentives received. The operating lease right-of-use assets are subsequently measured throughout the lease term at the carrying amount of the lease liability, plus initial direct costs, plus (minus) any prepaid (accrued) lease payments, less the unamortized balance of lease incentives received. Lease expense for lease payments is recognized on a straight-line basis over the lease term. The operating lease liabilities are initially measured at the present value of the unpaid lease payments at the lease commencement date.

Judgments used in applying ASC 842 include determining: i) whether a contract is, or contains, a lease; ii) the discount rate to be used to discount the unpaid lease payments to present value; iii) the lease term; and iv) the lease payments. We determine if a contract is, or contains, a lease at contract inception. A lease exists when a contract conveys to the customer the right to control the use of identified property, plant, or equipment for a period of time in exchange for consideration. The definition of a lease embodies two conditions: 1) there is an identified asset in the contract that is land or a depreciable asset (i.e., property, plant, and equipment); and 2) the customer has the right to control the use of the identified asset. ASC 842 requires a lessee to discount its unpaid lease payments using the interest rate implicit in the lease or, if that rate cannot be readily determined, its incremental borrowing rate. As all of our operating leases do not provide an implicit rate, we use our incremental borrowing rate based on the

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information available at commencement date in determining the present value of lease payments. Our incremental borrowing rate for a lease is the rate of interest we would have to pay on a collateralized basis to borrow an amount equal to the lease payments under similar terms. The lease term for all of our operating leases includes the noncancellable period of the lease plus any additional periods covered by either a lessee option to extend (or not to terminate) the lease that the lessee is reasonably certain to exercise, or an option to extend (or not to terminate) the lease controlled by the lessor. Lease payments included in the measurement of the operating lease right-of-use assets and lease liabilities are comprised of fixed payments (including in-substance fixed payments), variable payments that depend on an index or rate, and the exercise price of a lessee option to purchase the underlying asset if the lessee is reasonably certain to exercise.

The components of lease expense were as follows:
($ in millions)
Three Months Ended
September 30, 2019
 
Nine Months Ended
September 30, 2019
Operating lease cost
$
3.4

 
$
9.7

Short-term lease cost
0.1

 
0.5

Variable lease cost
0.8

 
2.3

Total lease cost
$
4.3

 
$
12.5



Lease expense for the three and nine months ended September 30, 2018 was $3.3 million and $10.4 million, respectively.

Supplemental information related to leases was as follows:
($ in millions)
Three Months Ended
September 30, 2019
 
Nine Months Ended
September 30, 2019
Cash paid for amounts included in the measurement of lease liabilities:
 
 
 
Operating cash flows from operating leases
$
3.2

 
$
9.4

 
 
 
 
Right-of-use assets obtained in exchange for new operating lease liabilities
$
0.3

 
$
8.4



As of September 30, 2019, the weighted average remaining lease term for operating leases was 11.8 years, and the weighted average discount rate was 3.76%.

Maturities of lease liabilities as of September 30, 2019 were as follows:
($ in millions)
Operating
Year
Leases
2019 (remaining three months)
$
3.4

2020
12.0

2021
10.2

2022
8.3

2023
7.7

Thereafter
48.1

 
89.7

Less: imputed lease interest
(16.4
)
Total lease liabilities
$
73.3




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Table of Contents

Maturities of future minimum rental payments under non-cancelable operating leases as of December 31, 2018 were as follows:
($ in millions)
Operating
Year
Leases
2019
$
13.0

2020
10.5

2021
7.8

2022
6.9

2023
5.5

Thereafter
37.8

Total
$
81.5



Practical Expedients and Exemptions

We have elected to adopt the leasing package of practical expedients, which allows us to not retroactively reassess: i) any expired or existing contracts containing leases under the new definition of a lease; ii) the lease classification for any expired or existing leases; and iii) initial direct costs for any expired or existing leases. We have also elected to adopt practical expedients around land easements, the combination of lease and non-lease components, and the portfolio approach relating to discount rates. These practical expedients were applied consistently to all leases.

We have elected not to recognize operating lease right-of-use assets and operating lease liabilities for all short-term leases (leases with an initial lease term of 12 months or less). We recognize the lease payments associated with our short-term leases as an expense over the lease term.

Note 7:  Affiliated Companies

At September 30, 2019 and December 31, 2018, the aggregate carrying amount of our investment in affiliated companies that are accounted for under the equity method was $84.0 million and $77.8 million, respectively, and the aggregate carrying amount of our investment in affiliated companies that are not accounted for under the equity method was $13.4 million at both period-ends. We have elected to record these investments, for which fair value was not readily determinable, at cost, less impairment, adjusted for subsequent observable price changes. We test these investments for impairment whenever circumstances indicate that the carrying value of the investments may not be recoverable.

Our purchases from, and royalty payments made to, affiliates totaled $33.0 million and $85.2 million, respectively, for the three and nine months ended September 30, 2019, as compared to $16.3 million and $64.0 million, respectively, for the same periods in 2018. As of September 30, 2019 and December 31, 2018, the payable balance due to affiliates was $24.3 million and $12.9 million, respectively. The majority of these transactions related to a distributorship agreement with Daikyo Seiko, Ltd. (“Daikyo”) that allows us to purchase and re-sell Daikyo products.

Sales to affiliates were $2.2 million and $6.9 million, respectively, for the three and nine months ended September 30, 2019, as compared to $3.0 million and $8.0 million, respectively, for the same periods in 2018. As of September 30, 2019 and December 31, 2018, the receivable balance due from affiliates was $1.4 million and $1.6 million, respectively.

Please refer to Note 6, Affiliated Companies, to the consolidated financial statements in our 2018 Annual Report for additional details.


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Note 8:  Debt

The following table summarizes our long-term debt obligations, net of unamortized debt issuance costs and current maturities. The interest rates shown in parentheses are as of September 30, 2019.

($ in millions)
September 30,
2019
 
December 31,
2018
Note payable, due December 31, 2019
$

 
$
0.1

Credit Facility, due October 15, 2020

 
28.6

Credit Facility, due March 28, 2024 (0.875%)
27.6

 

Series A notes, due July 5, 2022 (3.67%)
42.0

 
42.0

Series B notes, due July 5, 2024 (3.82%)
53.0

 
53.0

Series C notes, due July 5, 2027 (4.02%)
73.0

 
73.0

 
195.6

 
196.7

Less: unamortized debt issuance costs
0.5

 
0.6

Total debt
195.1

 
196.1

Less: current portion of long-term debt

 
0.1

Long-term debt, net
$
195.1

 
$
196.0



In March 2019, we entered into a new senior unsecured, multi-currency revolving credit facility agreement (the “Credit Agreement”) that replaced our prior revolving credit facility, which was scheduled to expire in October 2020. The Credit Agreement, which expires in March 2024, contains a senior unsecured, multi-currency revolving credit facility (the “Credit Facility”) of $300.0 million, with sublimits of up to $30.0 million for swing line loans for domestic borrowers in U.S. Dollars (“USD”) and a $20.0 million swing line loan for our German Holding Company and up to $30.0 million for the issuance of standby letters of credit, which Credit Facility may be increased from time-to-time by the greater of $350.0 million and earnings before interest, taxes, depreciation and amortization (“EBITDA”) for the preceding twelve month period in the aggregate through an increase in the Credit Facility, subject to the satisfaction of certain conditions. Borrowings under the Credit Facility bear interest at either the base rate (the per annum interest rate of the highest of the Prime Rate, the Federal Funds Rate plus 50 basis points or the daily London Interbank Offered Rate (“LIBOR”), plus 1.00%) or at the applicable LIBOR rate, plus a tiered margin based on the ratio of our net consolidated debt to our modified EBITDA, ranging from 0 to 37.5 basis points for base rate loans and 87.5 to 137.5 basis points for LIBOR rate loans. The Credit Agreement contains financial covenants providing that we shall not permit the ratio of our net consolidated debt to our modified EBITDA to be greater than 3.5 to 1; provided that, no more than three times during the term of the Credit Agreement, upon the occurrence of a qualified acquisition for each of our four fiscal quarters immediately following such qualified acquisition, the ratio shall be increased to 4.0 to 1. The Credit Agreement also contains customary limitations on liens securing our indebtedness, fundamental changes (mergers, consolidations, liquidations and dissolutions), asset sales, distributions and acquisitions. As of September 30, 2019 and December 31, 2018, total unamortized debt issuance costs of $1.1 million and $0.6 million, respectively, were recorded in other noncurrent assets and are being amortized as additional interest expense over the term of the Credit Facility. A portion of these costs relate to our prior revolving credit facility.

At September 30, 2019, we had $27.6 million in outstanding long-term borrowings under the Credit Facility, of which $4.6 million was denominated in Japanese Yen (“Yen”) and $23.0 million was denominated in Euro. These borrowings, together with outstanding letters of credit of $2.5 million, resulted in a borrowing capacity available under the Credit Facility of $269.9 million at September 30, 2019. Please refer to Note 9, Derivative Financial Instruments, for a discussion of the foreign currency hedges associated with the Credit Facility.

Please refer to Note 9, Debt, to the consolidated financial statements in our 2018 Annual Report for additional details regarding our debt agreements.

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Table of Contents


Note 9:  Derivative Financial Instruments

Our ongoing business operations expose us to various risks, such as fluctuating interest rates, foreign currency exchange rates and increasing commodity prices. To manage these market risks, we periodically enter into derivative financial instruments, such as interest rate swaps, options and foreign exchange contracts for periods consistent with, and for notional amounts equal to or less than, the related underlying exposures. We do not purchase or hold any derivative financial instruments for investment or trading purposes. All derivatives are recorded in our condensed consolidated balance sheet at fair value.

Foreign Exchange Rate Risk

We have entered into forward exchange contracts, designated as fair value hedges, to manage our exposure to fluctuating foreign exchange rates on cross-currency intercompany loans. As of September 30, 2019, the total amount of these forward exchange contracts was Singapore Dollar (“SGD”) 601.5 million and $13.4 million. As of December 31, 2018, the total amount of these forward exchange contracts was 10.0 million, SGD 601.5 million and $13.4 million.

In addition, we have entered into several foreign currency contracts, designated as cash flow hedges, for periods of up to eighteen months, intended to hedge the currency risk associated with a portion of our forecasted transactions denominated in foreign currencies. As of September 30, 2019, we had outstanding foreign currency contracts to purchase and sell certain pairs of currencies, as follows:
(in millions)
 
 
Sell
Currency
Purchase
 
USD
Euro
USD
39.3

 

34.2

Yen
5,921.1

 
31.8

20.2

SGD
31.9

 
18.7

4.3



At September 30, 2019, a portion of our debt consisted of borrowings denominated in currencies other than USD. We have designated our 21.0 million ($23.0 million) Euro-denominated borrowings under our Credit Facility as a hedge of our net investment in certain European subsidiaries. A cumulative foreign currency translation gain of $0.6 million pre-tax ($0.5 million after tax) on this debt was recorded within accumulated other comprehensive loss as of September 30, 2019. We have also designated our ¥500.0 million ($4.6 million) Yen-denominated borrowings under our Credit Facility as a hedge of our net investment in Daikyo. At September 30, 2019, there was a cumulative foreign currency translation loss of $0.5 million pre-tax ($0.4 million after tax) on this Yen-denominated debt, which was also included within accumulated other comprehensive loss.

Commodity Price Risk

Many of our proprietary products are made from synthetic elastomers, which are derived from the petroleum refining process. We purchase the majority of our elastomers via long-term supply contracts, some of which contain clauses that provide for surcharges related to fluctuations in crude oil prices. The following economic hedges did not qualify for hedge accounting treatment since they did not meet the highly effective requirement at inception.

From November 2017 through July 2019, we purchased several series of call options for a total of 301,326 barrels of crude oil to mitigate our exposure to such oil-based surcharges and protect operating cash flows with regards to a portion of our forecasted elastomer purchases.

As of September 30, 2019, we had outstanding contracts to purchase 107,909 barrels of crude oil from October 2019 to December 2020, at a weighted-average strike price of $71.15 per barrel.


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Table of Contents

Effects of Derivative Instruments on Financial Position and Results of Operations

Please refer to Note 10, Fair Value Measurements, for the balance sheet location and fair values of our derivative instruments as of September 30, 2019 and December 31, 2018.

The following table summarizes the effects of derivative instruments designated as fair value hedges on the condensed consolidated statements of income:
 
Amount of Loss (Gain) Recognized in Income for the
 
Amount of Gain Recognized in Income for the
 
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
Location on Statement of Income
($ in millions)
2019
 
2018
 
2019
 
2018
 
 
Fair Value Hedges:
 
 
 
 
 
 
 
 
 
Foreign currency hedge contracts
$
4.3

 
$
(2.0
)
 
$
(5.0
)
 
$
(3.4
)
 
Other expense (income)
Total
$
4.3

 
$
(2.0
)
 
$
(5.0
)
 
$
(3.4
)
 
 

We recognize in earnings the initial value of forward point components on a straight-line basis over the life of the fair value hedge.

The following tables summarize the effects of derivative instruments designated as fair value, cash flow, and net investment hedges on other comprehensive income (“OCI”) and earnings, net of tax:
 
Amount of (Loss) Gain Recognized in OCI for the
 
Amount of Loss (Gain) Reclassified from Accumulated OCI into Income for the
 
Location of Loss (Gain) Reclassified from Accumulated OCI into Income
 
Three Months Ended
September 30,
 
Three Months Ended
September 30,
 
($ in millions)
2019
 
2018
 
2019
 
2018
 
 
Fair Value Hedges
 
 
 
 
 
 
 
 
 
Foreign currency hedge contracts
$
(0.6
)
 
$

 
$
2.9

 
$

 
Other expense (income)
Total
$
(0.6
)
 
$

 
$
2.9

 
$

 
 
Cash Flow Hedges:
 
 
 
 
 
 
 
 
 
Foreign currency hedge contracts
$
0.7

 
$
0.1

 
$
(0.3
)
 
$

 
Net sales
Foreign currency hedge contracts
0.6

 
(0.5
)
 
(0.2
)
 
(0.1
)
 
Cost of goods and services sold
Forward treasury locks

 

 
0.1

 
0.1

 
Interest expense
Total
$
1.3

 
$
(0.4
)
 
$
(0.4
)
 
$

 
 
Net Investment Hedges:
 

 
 

 
 

 
 

 
 
Foreign currency-denominated debt
$
0.7

 
$
0.2

 
$

 
$

 
Other expense (income)
Total
$
0.7

 
$
0.2

 
$

 
$

 
 


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Table of Contents

 
Amount of Gain (Loss) Recognized in OCI for the
 
Amount of (Gain) Loss Reclassified from Accumulated OCI into Income for the
 
Location of (Gain) Loss Reclassified from Accumulated OCI into Income
 
Nine Months Ended
September 30,
 
Nine Months Ended
September 30,
 
($ in millions)
2019
 
2018
 
2019
 
2018
 
 
Fair Value Hedges
 
 
 
 
 
 
 
 
 
Foreign currency hedge contracts
$
3.9

 
$

 
$
(3.3
)
 
$

 
Other expense (income)
Total
$
3.9

 
$

 
$
(3.3
)
 
$

 
 
Cash Flow Hedges:
 
 
 
 
 
 
 
 
 
Foreign currency hedge contracts
$
1.0

 
$
0.2

 
$
(0.7
)
 
$
0.8

 
Net sales
Foreign currency hedge contracts
1.1

 
0.9

 
(0.5
)
 
0.4

 
Cost of goods and services sold
Forward treasury locks

 

 
0.2

 
0.2

 
Interest expense
Total
$
2.1

 
$
1.1

 
$
(1.0
)
 
$
1.4

 
 
Net Investment Hedges:
 

 
 

 
 

 
 

 
 
Foreign currency-denominated debt
$
0.5

 
$
0.7

 
$

 
$

 
Other expense (income)
Total
$
0.5

 
$
0.7

 
$

 
$

 
 


The following table summarizes the effects of derivative instruments not designated as hedges on the condensed consolidated statements of income:
 
Amount of Loss Recognized in Income for the
 
Amount of Loss (Gain) Recognized in Income for the
 
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
Location on Statement of Income
($ in millions)
2019
 
2018
 
2019
 
2018
 
 
Commodity call options
$
0.1

 
$

 
$
0.3

 
$
(0.5
)
 
Cost of goods and services sold
Total
$
0.1

 
$

 
$
0.3

 
$
(0.5
)
 
 


For the three and nine months ended September 30, 2019 and 2018, there was no material ineffectiveness related to our hedges.


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Table of Contents

Note 10:  Fair Value Measurements

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The following fair value hierarchy classifies the inputs to valuation techniques used to measure fair value into one of three levels:

Level 1: Unadjusted quoted prices in active markets for identical assets or liabilities.
Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.
Level 3: Unobservable inputs that reflect the reporting entity’s own assumptions.

The following tables present the assets and liabilities recorded at fair value on a recurring basis:
 
Balance at
 
Basis of Fair Value Measurements
($ in millions)
September 30,
2019
 
Level 1
 
Level 2
 
Level 3
Assets:
 
 
 
 
 
 
 
Deferred compensation assets
$
9.9

 
$
9.9

 
$

 
$

Foreign currency contracts
13.2

 

 
13.2

 

Commodity call options
0.1

 

 
0.1

 

 
$
23.2

 
$
9.9

 
$
13.3

 
$

Liabilities:
 

 
 

 
 

 
 

Contingent consideration
$
1.8

 
$

 
$

 
$
1.8

Deferred compensation liabilities
11.4