Ball Corp (BALL) 2004 Q3 法說會逐字稿

Thank you for standing by.

Welcome to the Ball Corporation 2004 Third Quarter Earnings Conference Call. (Caller Instructions.) As a reminder, this conference is being recorded Thursday, October 28, 2004.

I would now like to turn the conference over to Mr. Dave Hoover, Chairman, President and Chief Executive Officer of Ball Corporation.

Please go ahead, sir.

Thanks very much and good morning everybody.

This is Ball's conference call regarding the Company's third quarter 2004 results.

Before we begin, I need to say that the information provided during this morning's call will contain forward-looking statements.

Actual results or outcomes may differ materially from those that may be expressed or implied.

Some factors that could cause the results or outcomes to differ are set forth in the Company's 10Q filed on August 11, 2004, and in other Company SEC filings as well as Company news releases.

If you don't already have our earnings release, it's available on our website at ball.com.

Information regarding the use of non-GAAP financial measures may also be found on our website.

Joining me today are Ray Seabrook, our Senior Vice President and Chief Financial Officer, who's going to comment on our financial performance, and John Friedery, Senior VP of--and Chief Operating Officer of North American Packaging, who will talk about that packaging segment as well as our international packaging segment.

Well, today, Ball reported third quarter earnings attributable to common shareholders of $107 million or 90 cents per diluted share on sales of $1.48 billion.

That's compared to $68.8 million or 61 cents per diluted share on sales of $1.36 billion in the same period a year ago.

Per share numbers are adjusted to reflect the two-for-one stock split that occurred back in August of this year.

The third quarter 2004 results of 90 cents per diluted share include an after-tax gain of $4.2 million or 4 cents per diluted share related primarily to proceeds of asset dispositions in China being in excess of amounts, which we estimated and were included in a business consolidation charge taken back in 2001.

Our Company experienced quarterly earnings improvement in all three business segments, North American Packaging, International Packaging, and Aerospace.

It was a very strong quarter due in part to productivity increases and watching our costs.

Looking ahead, we believe that with one quarter to go in 2004, it's even more likely that our second half results could exceed the first half results And I'll talk about that in a few minutes.

But for now, I'd like to turn this over to Ray to give you some details on our numbers and then John will follow up with his comments on the packaging operations.

Ray?

Thanks, Dave.

Our business continues to perform well with third quarter earnings per diluted share up 28 percent over last year before the business consolidation activities.

In North America, food can results were much improved from the prior year, and beverage cans were also up in the quarter.

Internationally, our results in both China and Brazil were well ahead of last year.

Earnings per diluted share were improved by 2 cents in the quarter and 7 cents for the first nine months due to a stronger Euro.

Our efforts--our efforts to deliver the balance sheet are also paying off with third quarter interest expense lower by more than $5 million and projected full year interest expense lower by $23 million, an 18 percent year-over-year reduction.

We recorded a $6.7 million pre-tax gain in the quarter on the completion of business consolidation activities that were provided for in prior periods.

In China, proceeds on asset disposals and other items were $6 million higher than planned, while the completion of the North American plastics operations relocation to Colorado cost $700,000 less than estimated.

We expect to have completed all business consolidation activities by the end of this year with the exception of some final tax clearances in China that will probably occur in 2005.

Selling and administrative expenses were at 4.3 percent of sales for the quarter, lower than year-to-date rate of 4.8 percent, primarily due to lower employee benefit costs in the U.S. and slightly lower European costs.

The consolidated tax rate in the quarter was a little higher than 32 percent due to business consolidation gains being taxed at a higher rate.

Our fourth quarter tax rate could be somewhat reduced due to new--due to new U.S. tax legislation extending the use of R&D tax credits.

Our free cash flow generation continues to be outstanding.

In the third quarter we funded an incremental $20 million in our U.S. pension plans to reduce unfunded pension liabilities.

We have reduced our working capital billed this year to only $113 million through the third quarter.

As we look at the full year we expect all of the working capital billed to reverse in the fourth quarter and are planning to further reduce working capital levels employed in our business at year-end compared to a year ago.

Our latest full year capital-spending estimate is still in the $175 million to $200 million range, with about $70 million of spending scheduled to take place in Europe.

Even with a strong fourth quarter capital-spending plan, we anticipated full year free cash flow to exceed $350 million again in 2004.

Finally, a few words on the share buyback program and the balance sheet.

We are still on pace to purchase approximately $60 million of our stock in 2004.

Unless something better comes along, we foresee the 2005 share buyback program is still in the $200 million.

Net debt on the balance sheet at the end of last year was approximately $1.65 billion, and as we look to this year-end, net debt should be approaching $1.4 billion, a $250 million reduction.

Different than past years, however, we plan to have a sizeable amount of cash on hand at year-end to meet the requirements of the planned 2005 share buyback program.

And I'll hand it to John to review the packaging operations.

Thank you, Ray.

Our North American beverage can operations had another solid quarter.

Sales got off to a slow start due to retail price increases by our customers and some weather issues.

But we finished the quarter with shipments at the same level as in the third quarter of 2003.

We continued to see interest and demand grow for our line of custom cans.

As you may have seen in yesterday's press release, we are converting a line in our Golden plant from 12-ounce production to 24-ounce as we adjust our system to meet customer needs.

Additionally, we have just completed the first commercial run of new 12-ounce [sweet] can in Conroe, Texas and those cans will be filled and in the market in the near future.

Our beverage can plants are performing well and we continue to identify opportunities for further improvement in quality, efficiency, and costs, even as we complete actions on previously identified opportunities.

We believe we have good internal investment opportunities available to us in this business in the near term.

Our food can business continues to show good improvement over 2003.

Rigorous cost controls and better plant operating performance along with the additional volumes from the Oakdale acquisition and the full effect of the Milwaukee line edition have all contributed to this year-over-year improvement..

Sales volumes on food cans in the third quarter were down 3.5 percent compared to the third quarter of last year when you include the numbers from the Oakdale facility for both years.

On the same basis for the first nine months, sales volumes are up around 2.5 percent in 2004.

The seasonal pack started slowly in the quarter due to cooler than normal conditions in the Midwest, but a warm September allowed for a strong finish to the quarter.

The pack was very good with high quality product and it extended into the fourth quarter through mid-October.

We also had a solid salmon pack this season.

The steel supply situation continues to be interesting.

In that quarter we were again successful in securing the steel we needed to meet customer requirements.

As I stated in the previous quarter, much of this is through a lot of hard work by our purchasing, scheduling, and plant personnel and the cooperation of our suppliers.

In our PET business, we maintained our focus on cost containment in our CSD and water business during the quarter.

Capital spending was minimal in these segments, focusing on cost reduction and tooling maintenance.

The plants are running well.

Sales of PET bottles in the third quarter were down slightly versus the third quarter of 2003.

This was due to the same combination of retail pricing and weather issue that affected beverage can sales.

As in the can business, sales rebounded over the latter months of the quarter.

During the third quarter we continued to pick up spot sales on pre-forms and bottles due to some tightness of supply as growth in some segments continued to exceed forecasts.

We've said before that we are disinvesting in our commodity PET operations if we cannot get returns.

We announced during the quarter a new line of heat set PET bottles called Heat-Tek and we are focusing more on these and our multi-layer custom packages to grow the PET business.

I know someone will ask me about raw material price increases, so I will address it now by saying that we are going to pass-through all that we can.

It is our intention to maintain our operating margins in all of our businesses.

The fact is the economy is changing.

We are entering by all indicators an inflationary cycle and raw materials are going up across the board.

It is something we must deal with, while at the same time, making sure that our packages add value for our customers and their consumers.

Switching to Europe, sales volumes for the quarter were down 8 percent from the third quarter of 2003.

This reflects the effects of the cooler summer weather experienced in Northern Europe this year.

Additionally, 2003 was an unusually warm summer in much of Europe, which makes the comparison that much tougher.

The German deposit situation remains unresolved and that did have some effect on shipments this year as well.

In spite of the lower volumes in Europe, earnings were in line with expectations.

This is primarily due to effective cost controls in the plants.

Also, the closure of the [indiscernible] U.K. plant at the end of last year, the conversion of the line in Hermsdorf, Germany from steel to aluminum for export sales, and optimization of the production pattern within the German plants, have all helped to improve our cost structure in Europe.

Construction on our new Belgrade beverage can plant is progressing well and the plant remains on schedule for startup in the second quarter of 2005.

The European version of the sweet can is now available on the shelves in Germany as a so-called island solution.

This can will also be introduced in the market in early 2005 for a number of brand products in various parts of Europe.

The sweet can will be produced in Germany, which also helps offset the overcapacity situation there caused by the German deposit.

Our plant in Oss, Netherlands will be converted in early 2005 from steel to aluminum for custom cans.

With this conversion, Ball Europe will be better able to follow the ever-increasing energy drink demand.

Our businesses in China and Brazil continue to perform to expectations.

China is benefiting from a better cost structure following the completion of our restructuring efforts and in Brazil we are experiencing strong demand for our products as the summer season approaches in the southern hemisphere.

With that, I'll turn things back over to Dave.

Thank you, John, and thanks, Ray, for your comments.

The Aerospace and Technology segment of our business had third quarter earnings of $11.6 million on sales of $161.3 million.

That compares to last year's $10.6 million in profit on sales of $125.2 million.

The top line continues to grow and represents significant upside potential.

Aerospace margins are lower than a year ago as we work hard to manage the growth in this business.

We expect profit margins to return to more normal levels as we look to 2005 and beyond.

We've hired more than 500 people in that business so far this year and have a net increase of nearly 350 people with more in the hiring process.

We've entered two new to us market segments which serve the interplanetary market and the new DOD market.

Backlog in Aerospace was $688 million at the end of the quarter versus $644 million at the end of 2003.

You know, that's in the face of substantial sales increases as we saw.

We believe that the backlog should be higher at the end of this year compared to the end of 2003.

And, you know, as I say, we've grown the top line over 20 percent in 2004 while increasing backlog and we think that bodes well for the future in our Aerospace business.

Now to the outlook for the entire Company.

At the end of the second quarter, we said we believed our second half results in 2004 could exceed our first half results when we earned $1.21 per diluted share, that--as adjusted for the two-for-one stock split.

While our very strong third quarter, I think, clearly increases that likelihood, that would be despite the fact that the fourth quarter of this year will have five fewer accounting days.

You remember, we picked up six in the first quarter.

Well, we're giving five of those back in the fourth quarter.

So the year-over-year comparison will have--you'll have to take that into account.

We are benefiting from programs to control costs and keep operating efficiencies high and from new packaging choices for our customers that are expanding our custom packaging business.

The line conversion we announced yesterday for our Golden beverage can plant is the latest of these steps and we really believe that we have more good things in the pipeline here.

So all is performing well.

We think our capital structure is nearly optimum.

We continue to focus on improving our existing operations and we're continually looking at acquisition opportunities to add to our top and bottom line growth, although, as you know, we'll stay very disciplined in our search.

So with that, operator, I think we're ready to take questions.

(Caller Instructions.) Our first question comes from the line of Dan Kashaba of KSA Capital.

Please proceed with your question.

Good morning, guys.

Nice quarter.

You mentioned in your press release that you were going to be converting a 12-ounce traditional beverage can line to a specialty beverage can line.

Can you talk a little bit about how much capacity that will take out of your system on the traditional side?

And then, where some of those specialty cans might be going in terms of some of the growth opportunities?

Well, I guess I'd say first that, you know, our typical line is between 700 million and 800 million units, and so that will be--that will be what we'll be converting.

As far as where it's going, it is going to growing beer market and increasing the growth in the non-alcoholic segment as well.

If you walk into any convenience store or any grocery store you'll see increasingly--not just the beer segment in this, but a lot of the non-carbs as well.

Excuse me, carbonated and non-carbs.

Okay.

So most of this is for beer end markets?

Most of it is for beer end markets, your question?

Yeah.

Yes, the majority would be for beer end markets.

Okay.

And these are what--these are 8-ounce cans?

No, these are 24-ounce cans.

Oh, the 24-ounce cans.

Okay.

I was gonna say--.

Okay.

Then, if you could just comment a little bit about pricing expectations in the food can business.

Obviously, your business is doing a lot better because of the Milwaukee line producing more efficiently, sale prices are going up.

And how is that process going?

What are your customers saying in terms of, you know, understanding that food can prices have to go higher for next year?

First, let me say--and for any other questions that may come on steel, we have still not heard anything from the steel companies.

We expect to hear very shortly, but until we do we have no comment to make on that and we are awaiting that before we go out and speak directly with our customers.

We have, in general terms, talked with our customers and tried to get them--help them understand what's happening in the raw material markets and what the drivers are for this steel increase.

And I think we've made some headway in terms of getting people to understand that the raw materials of our material suppliers are in tight supply and in a rising cost environment.

And so, as with everybody, it's always tough when you begin talking about increases.

But we are dealing in facts and continue to work that way.

Thanks guys.

Our next question comes from the line of Ghansham Panjabi of Lehman Brothers.

Please proceed with your question.

Hi.

Good morning.

Just as a follow-up to the last question, can you give us the growth in North American beverage cans ex the 12-ounce can?

I guess, custom packaging?

I don't know if I have that out of CMI.

Let me look.

Excuse me just a minute.

It's a little tough to break that out for the industry.

The non-alcoholic cans, and that--and that would not include what we classify as custom because there's certainly some carbonated or some beer in custom as well.

But the non-carb growth, year-to-date for the industry is 4.4 percent.

4.4 percent.

Okay.

The--we're a large player in the custom market, so we're probably up a little more than that.

Okay.

And it seems like a lot of your competitors are also targeting these custom markets aggressively.

Could you sort of highlight how, you know, Ball views their position in this niche--in this niche market longer term?

Well, we've been in the market.

It's a market that we understand.

Our system allows us a number of multiple lines that we have for various products.

It gives us increased flexibility to meet customer demand.

And so, we believe that we've got a good position and we intend to continue in that position.

Okay.

And Ray, just real quick, the equity income was a little bit higher than we forecasted.

Can you--can you just give us some color on that?

It's--it's primarily Brazil.

Brazil.

Okay.

Thanks.

Good luck.

Thanks.

Our next question comes from the line of Amanda Tepper of J.P. Morgan.

Please proceed with your question.

Good morning.

Not to beat the dead horse on the U.S. volumes, but there was just so much investor worry over the last couple of months that they had really fallen off a cliff.

And it sounds like that was not the case for you guys.

And I'm wondering if you could just comment broadly.

Where are you seeing volumes coming aside from this specialty can size business?

And can you comment on private label and where Ball is positioned?

If some of the branded guys have a hard time over the next year or two and private label gains share, how would--how would that impact Ball?

Well, first of all, when you look at year-to-date number, for the quarter and year-to-date, for the entire industry when you look at the CMI numbers, I don't it's--when you say you guys I assume you are talking about the whole industry, because the industry was essentially flat.

And as I mentioned, July started off slowly due to some weather and our customers taking some retail pricing initiatives, but finished strongly.

And we kind of ended up about where the industry was, flat.

So the growth--or I shouldn't say the growth, but there has been some of our customers talking about their volumes being off a little bit as a result of these.

I think private label on the CSD side has picked up some of that and we are positioned with some private label manufacturers and so we are benefiting from that as well.

And then, on the peer side, I think cans have held their own in beer this year.

Okay.

And then post the conversion that you're doing in Colorado.

Where does that leave you on capacity?

Are you going to make it up on your standard cans via creep or is it cannibalizing over time your base business?

Well, we're--you could take a look at it.

The 12-ounce is flat to slightly declining over the last couple years and the growth has been in non-12-ounce containers.

But that growth or that--I'm sorry, that decline if--is pretty small.

So we're picking it up through creep, and not necessarily just cannibalizing our 12-ounce.

Okay.

And I know the margins are higher in custom cans, as you're now committing a whole new line to it.

Can you talk a little bit about what kind of returns you expect, either in margin return on capital or anything like that?

We expect to get returns in excess of our cost to capital.

That's specific and unspecific.

Okay.

Thank you very--pardon?

Amanda, our hurdle rate for capital projects is at least 9 or 10 percent after tax.

The hurdle rate.

Okay.

And it's in excess of that.

Yes, in excess of that.

Okay.

And, in Europe, this steel line conversion, did you talk about the cost of that?

And I assume that's going to hit the same kind of hurdle?

Do you recall how much it cost?

I'm thinking it's in the $7 million to $9 million range.

Yeah, it's completed.

It's been operational since spring.

I believe she's talking about the one I spoke of with the--.

--Oss or Hermsdorf?

We did--there were two that we discussed, Amanda.

But it--but it's about $7 million to $9 million per conversion?

Yeah, in that range.

Okay.

Thank you.

Our next question comes from the line of Richard Holohan of Smith Barney.

Please proceed with your questions.

Good morning.

I had a question.

I guess it kind of merges to other questions, but specifically on the conversion of the Golden line, the 6 or 700 million 12-ounce cans--I'm sorry, 7 to 800 million 12-ounce cans.

Did--did they find a home elsewhere in the system or are you giving up that business or how does that--how is that going to shake out?

They'll find a home elsewhere in the system.

How much--how much extra capacity do you think you have in the system right now?

You know, there's not a whole lot.

But if you begin to look at things like--on a system the size of ours, if you being to look at things--if we ran over Christmas holidays when we normally shut down, there's a little bit extra.

But we're in the low to mid-90s kind of utilization.

Okay.

And historically, how high is that?

What can you run at before, I don't know, people start to quit or machines start to break?

You get into the mid to upper 90s and you're getting really squeaky tight.

Okay.

And the second question was just on the German deposit situation.

Is there any kind of update, anything brewing beneath the surface there, either legislatively within Germany or within the context of the EU Commission?

I know that the--I know that the European Union had challenged the legality of that.

Most recently, I think a couple of weeks ago now, the [Boondisrocht] in Germany approved an approach to applying the deposit to containers that are medal, plastic and glass, one-way containers for most products with--excluding some things like milk and wine.

And, you know, it's sort of interesting to try to understand why and how they do what they do.

But that's what they've done.

The EU then subsequently, relative to the action that they had previously threatened or brought against Germany, has given them three months to sort of get their act together and put something together acceptable to the rest of the EU.

The EU's challenge is basically that Germany is denying a market to other EU members for their containers.

You know, we could theorize and get optimistic or pessimistic or anything else.

But I think that we're progressing and I think that there will be a better circumstance that evolves here than the one currently.

But right now, I don't think there's any news other than what I've just told you.

Okay.

Terrific.

Thank you very much, guys.

Our next question comes from the line of Edings Thibault of Morgan Stanley.

Please proceed with your questions.

Thanks and good morning, gentlemen.

David, I want to thank you first of all for bringing the term interplanetary market into a packaging conference call.

Definitely the first time I've hard and worth a laugh.

But good to see that business has some growth ahead of it.

I'm glad you were here to hear that, Ed.

Want to know, John, what the food can volumes were.

You mentioned down 3.5 percent year-over-year.

With the Oakdale acquisition, wondering what they were on a total basis, you know, without adjusting?

In other words, if you look at this year with Oakdale versus last year without?

Yeah--or just the actual numbers for Ball.

Well, the numbers this year--yeah, this year, if you take out Oakdale--if you don't--if you don't include Oakdale in last year's numbers we were up 15 percent.

Up 15 percent.

Okay.

And was food can--when you looked at it, I mean you guys posted a record profitability number as far as I can see in the North American packaging business.

Was a significant percentage of that increase, that 25 roughly percent increase, over last year's third quarter--how much of that came from food can?

Well we had--.

--A pretty good chunk of it, because, you know, we had a lot of good things going on.

Not only the addition of Oakdale, which is actually doing a little bit better than we thought.

And, you know, the Milwaukee situation is much better year-over-year.

So those are two contributors.

And then, the business performed better.

But you've got to remember, the beverage can business is a lot bigger business than the food can business.

So percentage-wise food is up a lot more than beverage cans.

But, would--would beverage cans be up?

I guess I'm trying to get a sense--you guys are launching or converting some of these custom packaging.

You are facing effectively flat volumes on the beverage can side and you're still able to eke out profitability gains in that segment?

Beverage cans are up.

Great.

That's good news.

And then, finally, a question on the PET business.

You know, you're still facing challenges there.

Sounds like you're focusing.

Can you talk to us about some of the specialized bottle growth that you're seeing in that market and what your percentage of your total production is sort of the heat bed and higher value-add?

Well, the percentage--the growth on an--on a percentage-wise basis is pretty high, because we basically didn't have any there before.

And we are, we've got a couple individuals dedicated to that.

We're talking with people who are going into new packages in that area, and we're getting a shot at those.

And so, we're picking up nice percentage gains.

It's still a small percentage of our business though today.

Great.

And then, one final question on the outlook for the fourth quarter.

Clearly, facing a smaller of shipping days in that business, but wanted to--you mentioned in your remarks, John, about sort of a late--a late harvest on some of the food can products.

As you look in that business, clearly, beverage can is going to be down and I think we can make our own guesses on year-over-year.

But if you look in food can, would you expect to see some benefit from that late harvest--that push out push back in October--offset the negative of the fewer shipping days?

How should we just think about that particular business?

Yeah, I think we will see some benefit from that and see some year-over-year improvement.

Great.

Thanks very much.

Our next question comes from the line of Chris Manuel of KeyBanc Capital Markets.

Please proceed with your questions.

Good morning, gentlemen.

A couple questions for you.

First of all, with regards to your custom can business.

I think a few quarters back you indicated that that was about 10 percent or so of your capacity was in the custom can area.

After this conversion is done, you know, that--where does this leave you then?

Is that--does it push that up a bit?

Yeah, it pushes it up a little bit.

It's in the--in the low teens.

In the low teens.

Okay.

That's really speaking to North America.

We also make custom cans in Europe.

That's correct.

I don't know the percentage there, but--.

--It's a small percentage there as well.

With this, it will be similarly below 10 percent.

Okay.

And then, as far as the--if I could touch again on the steel issue, in Europe they're talking about steel prices being up roughly 20 percent.

And I know you indicated that you anticipate passing along steel prices as well in North America.

But, do you have any sort of an indication, one, as to steel costs?

Is it a similar sort of order magnitude here domestically?

And then, two, do you anticipate that net of raw materials that you'll be able to get any price?

You know, as John said earlier, we really have not heard anything official from the U.S. steel industry.

So we'd just be speculating.

But recall that they did get price increases last year plus a surcharge.

And I don't believe the European industry did that.

So I wouldn't try to look at what Europe is saying and think that would automatically be applied here, but since I don't get to run those businesses, I don't know what they're gonna do.

As John said, what we're trying to do is, you know, communicate well, not only with our suppliers, the steel people, but our customers.

First we've got to make sure we can secure supplies and I'm optimistic that we're going to be able to do that next year, both here and in Europe.

And secondly, we're going to do all that we can to keep the price increase down.

But, you know, to on a conference call sort of bait the steel companies about what I think they're going to do would be foolhardy, I believe.

But what we'll do is all that we prudently can to continue to deliver good value to our customers here.

And then, net of price--net of raw materials, do you think you'll be able to realize any price in the food can business next year?

It's really kind of early to say for all the reasons we've just been saying.

When you say net-net, I guess, let's turn that a different direction a little bit and say can we improve margins further.

You know, what we really always are focused on--what we'll have to particularly in these kind of times is, you know, look to yourself first and get cost out of the business.

I think we've still got some things that we can do that way.

Certainly, we'll have full year of the Oakdale plant.

Milwaukee is running well, but probably can do better.

The whole system there are ways to improve.

So we're gonna try to take cost out and we're gonna try to be rational and prudent with our customers.

I did hear on the radio I think a day or two ago that a couple of people who make soups that are our customers are already talking, you know, publicly about the fact that they're faced with cost increases, including packaging.

So, you know, I think the message is getting through.

We've just tried to communicate with clarity.

We don't like this, you know, particularly with the big jumps, but we've got to defend ourselves, because our margins won't let us basically absorb the kinds of increases that are talked about.

Okay.

One last question for you.

I realize that you've talked about in the past that your plastics business operates, you know, below the cost of capital.

But with this new, you know, the heat set business and that sort of stuff, is that particular segment--does that operate above the cost of capital or is that still--I know it's better than your other business, but is that--is that still below or how does that fare?

I think we think that if we can get the volumes at levels that we want that that's the idea and I think we probably can see that.

As John mentioned, you know, we're basically spending less than depreciation, so the investment goes down.

And I think we've talked before about the fact that our plant and equipment in that business is relatively new, so still, you know, the depreciation in the business is higher as a percent of sales than in the other businesses that we're talking about here.

In terms of the [indiscernible], the gap isn't as big as it is in terms of reported EBIT.

And, you know, we're probably a company, as you know, that focuses on cash.

So we don't hate the business, we're just trying to make it better and we're making some inroads in areas that we think are gonna permit us to do that.

And I think it's also helpful that, you know, as the industry is looking at this, you know, not just us, but some competitors are taking actions which hopefully will improve the commodities side of the business.

Okay.

Thank you very much.

Our next question comes from the line of Mark Connelly of Credit Suisse First Boston.

Please proceed with your question.

Thank you.

Just wanted to go to working capital for a second.

With the--with the outstanding food volumes and the, you know, relatively good beverage stuff, too, I'm just wondering if we're going to see any unusual working capital swing between the third and the fourth quarter?

No, I don't think so.

You know that, you know, we below a lot of cash in the fourth quarter primarily because of our food can business.

The one thing that you will notice is you can see that our payables are a little higher than normal and one of the reasons for that is is that, you know, that reflects all of these raw material price increases that you've seen.

But you should see the working capital, you know, the similar patterns this year, as the other years.

Okay.

And just one last question.

You've talked about CapEx for the year of 175 to 200.

You spent, well, a little less than I expected this quarter.

Is that still the right range?

That's what we said.

That's what everybody's telling us.

I find it hard to believe we could spend that much money, myself, in the fourth quarter.

But that's everybody's telling me.

So--good opportunities and we're working on it from an operating side.

Okay.

Outstanding results.

Thank you.

Our next question comes from the line of George Staphos of Banc of America.

Please proceed with your questions.

Thanks, operator.

Hey guys.

Good morning.

A couple of things.

Some housekeeping first.

In terms of the outlook for the second half of the year, are you including the four cents from the gain or not?

No.

Okay.

Fair enough.

Now, secondly, in terms of custom, your niche here, you're really acquirers for Reynolds.

Would that be right, John?

That's correct.

And they were always the market share leader in custom cans anyway.

I mean, it was with juice cans and that sort of thing.

Has that--has your share expanded in custom over the years do you think, or do you think that since everybody else has gotten into the business that you have maintained the leadership, but saw that share position erode a little bit?

I'd say that we've maintained a leadership I don't know that it's eroded, but I think the pie is growing and everybody is taking a look at it.

Gotcha.

Now the volume number that you cited in Europe, was that including the decline?

In other words, were you not adjusting for Germany last year?

Because last year you were down, as I recall, because, obviously, Germany was down.

Yeah.

I mean, I think it's--the same numbers that--they're not adjusted numbers.

They are actual volume numbers.

Okay.

So if I heard you right--.

--A portion of it--a little bit of it was the German effect.

The majority was, you know, cooler this year and much warmer last year.

Right.

But I guess the point I'm making, you were down, whatever you said, 8 percent, 7 percent, and that was off of a quarter last year where you were down 10 percent, including Germany, which tells you that, you know, whatever you guys did over in Europe this quarter and this year really paid off from an operating standpoint.

That's right.

Correct.

Where did you guys find an extra $25 million in free cash flow this year?

And is it coming more from working capital or just more efficiency?

And what do you think the true normal cash flow is for this business in the next, call it three years, on an--on an annual basis?

Don't let him trap you now, Ray.

Well--.

--Ray's too quick for that.

Come on.

Now--the--well, here's what I would tell you, George, is that, you know, you've seen it yourself.

The last two years we did 350 plus.

You know, these businesses can do better than that.

I'm not gonna give you a number.

But what I also know is as I look out to the future and I see some opportunities where we have a chance to spend a little bit of money to make money.

So I think that I can see our capital expenditures potentially increasing a little bit, because we're looking at some good opportunities as I look a little forward.

So I think we continue--can continue to generate significant cash flow, but look for--probably look for our capital strength to creep up a little bit and we'll tell you--we'll tell you what we're gonna do with it when the time comes.

But presumably, if the CapEx is creeping up, given that you're putting it into growth businesses, [indiscernible] I remember you saying in the past just on the emerging markets, those are probably more cash accretive than your existing businesses.

So maybe you actually--even though you are throwing CapEx at it--that's not the right term, I realize.

You are actually becoming more free cash generative when you do it.

Would you agree with that or disagree with that?

Remember what I said in my comments.

I said that we, you know, we should be in excess of 350 this year.

That's including the $20 million we funded into the U.S. pension plans.

And that's assuming we spend basically between $75 and $100 million of capital expenditures in the fourth quarter.

If we spend less, obviously, that number goes up.

So you can see that the cash flow generation of these businesses is pretty significant.

Okay.

Dave, last question for now anyway.

Just on Aerospace.

Were the margins where you had expected them for the third quarter?

I remember you saying in February you'd see some improvement, which you did, but perhaps not as much as we would have expected.

Were you tracking relative to where you had expected, and if not, why not?

Well, a little less than I might have expected, although in the right direction.

And I think I might want to deconstruct this just a little bit, because the lion's share of that business and the programs that are being conducted are performing fine and are making, program by program, the margins that we would have expected.

In these newer markets, we've got a couple of program where we're not getting much fee and we got a little sales growth, so that works against you.

And then, we also had some things, you know, last year we got five--$4 million or $5 million, $6 million maybe up for this ISAT payment that came in the first quarter of the year.

That's not there this year.

This year we've got some costs associated with pension and healthcare that are higher, because of the way we have to do accounting in Aerospace, than they were a year ago.

So I could go through all that with you.

But if I do all that and I look at the business, it's performing relatively better than the gross that you see would look like.

It's still not up to where we want it, and I think it's gonna improve.

Right.

And I realize that it's hard to get into the granularity, but the backlog as you see it would be comparable margin relative to what you've historically, you know, business you've been able to win over the years?

Yes, or even a little higher, because we actually are taking--I think we're probably 35 to 40 percent fixed price as we see some of these programs, like the program that we're doing for WorldView--or the WorldView program for Digital Globe.

You know, it's a large--a large project over a couple, three years.

The other thing is that, you know, as we--as we complete projects, and particularly where they're fixed priced, we'll be conservative as we always are in accruing profit.

And when you're on the front-end of these things, you tend not to be aggressive, and that's just our nature.

And we're not--it isn't anything other than just the way you're supposed to do it.

But when the mix of business gets as it is today where we've got a few new starts going on, and when they're in the fixed price or even sometimes in the cost type world, we're just not accruing at rates that we'd expect the program to do through the full phase if we're successful as we want to be.

So I'm not particularly worried about that.

I am concerned that we continue to understand that we're growing at a high rate.

We're bringing a lot of new people.

We're putting more resource to training, educating.

We're running the businesses [indiscernible] with a harder edge.

You know, we've hired Bill Townsend who comes to us from Goddard.

He's running our civil space business.

If you check into his background, he's a great guy.

I just see a lot of good things coming up for that business.

I think the sales growth this year is stilted a bit.

There's too much of it, frankly.

I wish it was a little lower.

Next year the sales growth may be lesser in terms of a percentage.

I think the profitability should improve next year, but, you know, as we manage the business, we're on a good track and I like what I see there.

Thanks, Dave.

Our next question comes from the line of Richard Holohan of Smith Barney.

Please proceed with your questions.

[Indiscernible.] I had a question on capital structure going forward and to the extent that you generate more or less cash next year.

Can you give us guidance on what you intend to do with it, subject, of course, to acquisition opportunities?

To the extent that you do generate more cash next year, what--does it continue to flow into share repurchase?

Where do you want to be in terms of debt to cap, that sort of thing?

Well, we looked at our capital structure pretty hard this year.

We delivered, you know, we made that acquisition of [indiscernible] a couple of years ago and we delivered, you know, the balance sheet pretty strongly since we did that.

That's what we said we were gonna do and we did it.

So we wanted to make sure well where are we going to.

So we think that where we will be at the end of this year is a pretty good capital structure for our Company.

We're gonna continue to pay off some debt, because we have--we have debt requirements to continue to pay it off.

But we've obviously gonna slow that down.

As we've said, we're gonna take a lot of the free cash flow next year and buy back stock.

And I guess until something better comes along, we're gonna kind of continue on that note.

But really, if you think of it, we are not going to sit on the money.

It's our shareholders' money.

And, you know, it's our job to be able to make a return in excess of this 9 percent Ray was talking about and we'll keep--we'll do all of that that we can.

And what we--what we have is extra above the sort of comfortable that we are, we are going to return to shareholders.

And we increased our dividend this year, but a lot of that will come in the form of share buy, which gives the shareholder the ability to stay or take the money.

And we just think that's the right thing to do.

I would tell you that the way we're structured, this Company has the capacity in my judgment to borrow a substantial amount of money to make good acquisitions.

So we're not restrained at all by returning this capital to the shareholders in pursuing a prudent strategy for growth.

And, you know, I suspect that we could afford and, you know, the way the financing markets are and with the credibility the Company has, to borrow more money to buy something than we probably prudently can manage.

So we're just not constrained in that regard.

Well, thank you very much.

(Caller Instructions.) Our next question comes from the line of Edings Thibault of Morgan Stanley.

Please proceed with your questions.

Thanks.

A quick follow-up.

I don't want--I know you guys are sensitive on the issue of steel costs.

But perhaps approach that a different way.

Your contracts give you--price protection gives you the ability to pass that through to your customers, right?

So it's really, when you're talking about sense of negotiations, it's understanding what your future steel price is likely to look like and being able to communicate that to your customers.

I mean, am I right in assuming that you have that cost pass through protection that you've always enjoyed?

I'll let John comment a little more on this, Edings, but that's not universally true.

It's not--it doesn't work quite the same way in Europe and in the food business.

You know, some do, some don't.

But the real thing that I would just editorially, and you may want to comment further John, is that at issue here is, you know, the economic viability of the--of the container and how it affects our customers.

When you get into increases that are so high that it could begin to affect demand.

And so, that's sort of what we're worrying about.

But we've--we community with clarity and we're not gonna do this for practice.

I will tell you that.

So we'll work hard to keep the cost increase down, and then we'll price our product accordingly to be able to make a return.

As Dave said, we are certainly aware of the fact that ultimately that we're selling the customers who are looking at the same issues and saying they've got raw material cost increases that they're gonna need to pass through and ultimately it's the consumer.

And the consumer's not just getting hit from package food and beverages.

They're getting hit at the gas pump.

They're getting hit on home utility bills.

And, you know, eventually, people either switch to something else or just don't buy.

We certainly are aware as we go forward that we're--this is an inflection point.

We've enjoyed a nice long period of low inflation and the ability of retailers to deliver value to the ultimate consumer, and that appears to be at a point where we're getting some changes to the whole system right now.

And so, we're very aware of that and are going to make sure, and want to work with our customers, so we maintain the viability of all of our packages, food cans, beverage cans, and PET bottles, all the way down the line into the future.

Great.

Thanks for the amplification.

Our next question comes from the line of George Staphos of Banc of America.

Please proceed with your question.

Hey guys.

Two quickies.

One, the short-term--Ray, the tax rate for the fourth quarter, where would you guide us to then?

Sorry, George.

I missed that.

Tax rate.

You said fourth quarter could be down because of R&D--.

--There has been a lot of recent tax legislation going on.

And they'd extended R&D tax credits which has an impact in our Aerospace that does affect our tax rate.

So what I said was, you know, we've been saying all along, it looks like around a 32 percent tax rate looks about right for the Company.

Now that they've extended the R&D tax credit--R&D tax credit legislation that I think maybe in the fourth quarter we could be a little lower than that rate.

But we're not talking about 25 percent either.

Do you still [indiscernible]?

Yeah, oh yeah.

Exactly.

Fair enough.

Longer term, if we think about the North American metal packaging businesses, and let's say we've now stepped away from this environment where costs have been going up and you're worried about what the implications are for growth, etc.

In this steady state, what type of EBITDA growth do you think you can get within North American beverage and food combined, just from your ongoing productivity and cost reduction efforts?

Don't include mix in this answer if you can.

Thanks.

That's a tough question to answer because you have to make volume assumptions, ultimately, and you have to make--we talk about material.

You talk about there's other inputs such as labor, utilities, and this is a volume sensitive business.

So I think to make one outside of a--make an estimate outside of a long discussion around where everybody believes volume is going is kind of not too meaningful.

Well, John, I did say keep the volume stable and North American metal doesn't really grow that much.

So if you assume volumes are flat, I mean, does your productivity at least keep up with installation?

Productivity--well, again, productivity yields, as you're saying, productivity increases to keep up inflation and volume flat, that's gonna yield excess capacity within our system certainly when we just look at our micro universe, which would then say you'd have to take some actions.

So, again, I just don't know that there's a good way to put an answer to that question that makes any sense given all the variables.

Hey, you know, the thing is, George, the mix is shifting, and especially the can business is growing.

And we're doing a lot of work around product improvement, product enhancement, new products to existing customers same and new products to new customers.

I think though that maybe if we--what we're getting at, or what you're trying to get at, do we think that we can continue to take cost out of the business.

And I would say absolutely.

And not only--not only do we think, but we can and we will.

And, you know, some of the money that Ray was talking about earlier, that we may tee up and spend within our business will basically be focused more on getting the cost structure down in the face of a flatter market than on improving [indiscernible].

And we've got things that we've identified that I think we're gonna probably proceed with and get some results.

So, you know, it's easier to get margin improvements when your margins are lousy and you can just sort of slop into and close a plant or something easy happen.

So it gets harder, but, you know, that's what we're focused on.

That's what our incentives cause us to do and I'm confident we're gonna keep doing it.

Dave, that's what I was gonna ask.

Very helpful.

Thanks guys.

Good luck with the rest of the year.

Our next question comes from the line of Andy Finman of Meridian.

Please proceed with your question.

Thanks.

In your release you said that food can sales were up 25 percent.

Did you--if you did I apologize for making you repeat this.

But could you break that down into units and--versus price?

Andy, I think--it's Ray.

I think what--I think what John said earlier in the call, he said the units in the third quarter were up 15 percent.

So, the rest has to be priced.

And of course, it's not--it's priced--remember also, that's really the steel price increase pass-through.

So 15 percent, I guess, has a lot to do with Milwaukee, the reason why it's up so much?

That's only the Oakdale position.

Oh, okay.

Right.

Okay.

And the --any securitized receivables, any change in that during the quarter?

It was $200 million I think at the end of June.

Yeah, same number, Andy.

Okay.

And the--you know, you talked about expanding in Aerospace, but then you said that--and also with projects like [Belgrade], but then I--then you said even including those things you'd still want to buy back $200 million of stock and pay down at least $60 million worth of debt.

So, I understand that those are things that could happen.

But, you expect to do both, not one or the other?

Expect to do all of those things you mentioned.

All right.

Remember the Belgrade plant is going to be operational second quarter of next year.

A lot of that spending is happening this year.

That's--.

--Well, but I think you were talking in that release about additional projects.

Say we see attractive opportunities over the next couple of years through projects like Belgrade and then expansion in Aerospace and--but, then you say that we also expect to buy back $200 million of stock.

So I just wanted to make sure it wasn't either or.

That you were gonna do all those things and I was reading it right.

The only other question I had, you know, you talk about the new products and in that paragraph you say we have more in the planning stages.

I mean, do you want to talk any more about how much that could really help your business going forward, because it's probably the most exciting thing going in the mechanics side.

It sounds like you're doing a really good job with it.

And it sounds like this conversion that you're talking about is one, but you're looking at a lot of ideas to move up the food chain into higher margin products in that business.

Yeah, I'd like to, but I don't think we should.

But, you know, we are looking at a variety of things to do.

You know, at any given time in the business, we've got things identified from small projects that--to somewhat larger ones, and we try to time them consistent with many things.

You know, even though we say we want to get more than 9 percent, most of the people in our business don't bring anything forward unless it's a lot better than that.

And I just think we've been, you know, we've--our plants are in good shape.

We spend a lot of maintenance money through the P&L to keep them that way, but I think it's time that we spent a little more money on some really good return projects and stay probably more focused on in the U.S. on cost reduction in the standard beverage business, but in the specialty businesses and so on, like the conversion over at Golden.

You know, it's really growth in a new market.

So we're pretty optimistic that we can continue to find those opportunities, Andy, and we continue to look for other things to do.

It's hard--it's hard in the acquisition market these days, you know.

You see some of the big deals, the more publicly disclosed ones where people are paying what appear to be pretty high prices.

So we've got to look even harder and we're doing that.

Could I just--I'm sorry.

I thought of another question I'd like to ask you, Dave, if you don't mind.

And that is, you are competing against new bottles and you've got a new re-energized competitor going to Illinois that, you know, wants to do things smarter and better than they've done before.

Have you thought at all about how that might affect your business either negatively or positively, because I can see both sides.

Well, I think with Owens or any competitor, you know, their improvement, as long as it's occurring because they're acting prudently and making good business decisions, making good returns, should be good for everyone in the--if you understand what I'm saying.

I do.

I think that their business is different than our, but we were in the glass container business for a long time.

One of the tricks there is to be able to conduct it in a way, in my opinion, that you can flow some cash.

And to do that, I think margins have to get better and I, you know, I'm pleased they are doing better.

But I think the success for glass over the last few years has been in beer bottles and then it's been a little bit at the expense of the can.

I don't think you're gonna see a huge swing there, but that's a place.

But in many cases the glass industry has been faced with the conversion to plastic.

Some of the things that we're doing with our Heat-Tek business are going in that direction.

So, on balance, we just all have to get out there and compete and do the best that we can, but if you go to the grocery store, as I do from time to time, it just seems every time I go there is something else sitting there in a plastic bottle that used to be in a glass bottle.

So--.

Right.

Thank you.

Mr. Hoover, there are no further questions at this time.

I will now turn the conference back to you, sir.

Guess we'd better quit then.

Thanks everybody for joining us today and we'll look forward to speaking with you after the first of the year.

And hope you have a good rest of the year and a good holiday season.

Ladies and gentlemen, that does conclude our conference call for today.

We thank you for your participation and ask that you please disconnect your line.