Sonoco Products Company Q3 2008 Earnings Call Transcript

Oct.16.08 | About: Sonoco Products (SON)

Sonoco Products Company (NYSE:SON)

Q3 2008 Earnings Call Transcript

October 16, 2008 11:00 am ET

Executives

Roger Schrum – VP, IR & Corporate Affairs

Charlie Hupfer – SVP, CFO & Corporate Secretary

Harris DeLoach – Chairman, President & CEO

Analysts

George Staphos – Banc of America

Claudia [ph] – JP Morgan

Mark Wilde – Deutsche Bank

Ghansham Panjabi – Wachovia

Chris Manuel – KeyBanc Capital Markets

Tim Burns – Cranial Capital

Operator

Greetings, ladies and gentlemen, and welcome to the Sonoco Products Company Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator instructions). As a reminder this conference is being recorded.

It is now my pleasure to introduce your host Mr. Roger Schrum, Vice President of Investor Relations. Thank you, Mr. Schrum, you may begin.

Roger Schrum

Thank you, LaTonya. Good morning, everyone and welcome to Sonoco 2008 Third Quarter Earnings cum Investor Call. Joining me today are Harris DeLoach, Chairman, President and Chief Executive Officer and Charlie Hupfer, Senior Vice President and Chief Financial Officer.

Our financial results for the third quarter were released before the market opened today and are available via our Web site at sonoco.com.

Let me begin by stating that today's investor call may contain a number of forward-looking statements that are based on current expectations, estimates, and projection. These statements are not guarantees of future performance and are subject to certain risks and uncertainties. Therefore, actual results may differ materially. Additional information about factors that could cause different results and about the use by the company of non-GAAP financial measures is available on Forms 10-K, 10-Q and 8-K, filed with the SEC.

With that brief introduction, I'll now turn it over to Charlie Hupfer.

Charlie Hupfer

Thank you, Roger. Today, Sonoco reported third quarter financial results. We reported that EPS on a GAAP basis is $0.57 a share and the base EPS was $0.60 a share. The base EPS is $0.60 a share, was below our guidance of $0.63 to $0.65. We were not displeased with this quarter but frankly, September was a little weaker than we had expected especially the last half of September.

Let me start by reconciling the reported earnings to base earnings. In the third quarter, we took a $5.5 million pretax restructuring charge, related to the closure of one paper mill and one converting plant. Tax benefit on this charge was $2 million and there was a 2/10 million or $200,000 restructuring adjustment in the equity and affiliate section. The net effect of all of that is that $3.3 million or $0.03 is added back to GAAP net income to arrive a base net income of $60.6 million and base EPS of $0.50 a share.

Reconciling the third quarter of 2007 GAAP to base is more complicated. Last year, GAAP earnings of $464.5 million or $0.63 a share including restructuring, asset impairment and an adjustment to the environmental reserve of – all that total $18.5 million. Related tax benefit on the $18.5 million was $6.4 million which means the net was $12.1 million around in the $0.13 a share.

In addition to that, going in the other direction was a tax credit of $11.8 million or $0.12 a share. That's the tax credit that we brought into income when the statute expired on our 2003 tax year. The net of the pluses and the pluses were $0.13 a share and the minus is $0.12 a share was an add back of $0.01 per share to arrive at base net income of $64.8 million and base EPS of $0.64 a share last year.

If you had trouble following that let me read out the comparative base income statement for you. Starting with sales, sales were $1.0633 billion that's up $33.5 million or 3.3% from last year's $1.0298 billion.

EBIT – earnings before interest and tax was $91.7 million, that's up $200,000 or 0.2% from last year's $91.5 million. Interest expense in this quarter was $10.6 million versus $14.1 million in last year's third quarter. That leaves us then with profit before tax of $81.1 million which is up $3.6 million or 4.7% from 2007 $77.4 million.

Taxes were $23.8 million versus last year taxes of $16.2 million. Affiliate income was pretty much the same year-over-year $3.4 million this year compared with $3.5 million last year. So that leaves us with base net income which were $60.6 million, down $4.2 million or down 6% from last year's $64.8 million. Base EPS was $0.60 per share compared with $0.64 per share last year.

Now let me comment on taxes and the effective tax rate. In the third quarter we generally have adjustments to reserve as well as true-ups to the tax accrual to reflect the file federal and state tax return. In the third quarter 2008 we had $3.8 million of what I will call discrete adjustments in the quarter. These adjustments brought the effective tax rate down to 29.4%.

Last year we had $10 million in discrete adjustment and the effective tax rate was brought down to 20.9%. That's the difference in dollar terms of about $6 million of discrete adjustments or $0.06 per share. And that's why you see profit before tax is up year-over-year by 4.7%, the profit after tax and base EPS is down around 6% year-over-year.

In our segment reporting that it tells pretty much the same story as it did in the first and second quarters. And that is a strong consumer segment offset weakness in the other segments.

Looking at the consumer segment first, sales were up 7.9% year-over-year, EBIT was up 21.8% year-over-year. Sales and profits were driven by good volume in our domestic can operations and our domestic metal end operations. Profits were 44% up year-over-year in the second quarter last year as opposed to 21.8% in the third quarter this year. The big difference between the third quarter and the second quarter is weakness in our European can volume and lower productivity in the U.S.

Looking at the tube, core and paper segment sales were up 0.5%, EBIT was down 3.3%. By way of reference EBIT in the first quarter was down year-over-year by 15%, and it was down 6.8% in the second quarter year-over-year as compared with being down 3.3% in this year's third quarter. Volume has not changed much from the first and the second quarter level. We did see a better price cost picture in the third quarter due principally the energy surcharges. I will talk a little bit more about pricing in a minute.

And then the Packaging Services segment, sales were up 2%, and EBIT was up 16.9%. This reflects the impact of lost volume in price due to last year's bidding activity by major customers. We have started to grandfather all of the price impact, but only some of the volume impact.

And then all other, sales were down 0.6%, EBIT was down 12.3%. This segment is where our protective packaging and our baker reels business is reported. And they service and they clearly been affected by the housing slump.

Now let me turn to the sales bridge where we reconcile last year's sales of $1.0298 billion to this year sales of $1.063.3 billion. That's a positive difference of $35.5 million. That (inaudible) volume which is negative $31.8 million, price which is positive $30.4 million, acquisitions net of divestitures is a positive $8.1 million and foreign exchange is a positive $26.1 million.

So to repeat, negative volume $31.8 million, positive price $30.4 million, acquisitions $8.8 million and foreign exchange $26.1 million, and that should add up to the year-over-year difference of $33.5 million.

Volume was generally weak in all our tube, core market, that is the U.S., it's Europe, it's Asia, in all markets except for South America where we did see year-over-year improvement. In the U.S. and Canada, volume was down 5.5% year-over-year which is pretty much in line with the second quarter where our reported as volume was down 5.3%.

Textile volume in this third quarter was down year-over-year 20%, paper mill core volume was down 3.3%, tape and specialty volume which was generally flat year-over-year.

Volume in Europe, overall was down 4.6%. It was down 4.8% in what we call legacy Europe, that was the U.K., Italy, France, Spain, Finland. Volume on the other hand was up 5.3% in what we call Frontier Europe, in their Turkey was up 10.7% year-over-year.

Our domestic paper trade sales volume was down 7.67%, and that's a result of closing the paper machine and some loss volume as we raised paper prices. Volume was down in Canada around 8% due to the closure of our Montreal paper mill.

On the other hand volume was up 3% in composite can where snacks volume up 16%, refrigerated dough volume was up 8%, miscellaneous food volume was up 30%, that's due to costly conversions that we made, and we are producing the ensure plastic bottle this year which we weren’t producing last year.

Metal end volume and mix was positive and in line with the composite can growth. Our flexible volume was down around 2% that's due to a combination of slow sales to major customers and some business loss to a competitive bid.

Packaging services volume was weak, again that's largely at our core flex operations and it’s entirely due to a bid we talked about before with a major customer where we gave up those volume and price. And volume was down in the all other category and that's the category again that falls into the housing and the housing related market.

Prices though added $30.4 million as a result of price increases implemented through the year to offset higher raw material and energy costs. Most of the increase in prices was in the tube, core and paper segment and in consumer segment.

Earlier in the year, we announced a $40 a ton paper increase and an 8% tube increase. In July, we announced a $40 a ton energy surcharge on paper. We announced a 10% increase in caulk cartridges in August due to higher resin costs.

On September 1st we announced a $50 a ton paper increase that replace the July surcharge. In the mid-September we announced a 5% tube increase. So lot of pricing activity on the domestic front to offset higher material, energy and freight costs.

In addition, we had the usual contractual resets with our tube, core and paper, composite can and plastic customers. European pricing was up year-over-year due to a January price increase followed by selective increases throughout the year. On the other hand, there is a negative recovered paper prices were down year-over-year as the Southeast yellow sheet averaged $110 for the quarter versus $135 last year.

Acquisition accounted for a net $8.8 million in sales. The majority of that increase came from our October 2007 purchase of Caraustar's composite can and cartridge business. And foreign exchange accounted for $26.1 million of increased sales. This just simply reflects the effect of the weak dollar in translating the Euro versus Brazilian Real and the Polish Zloty. All of this is translation. So the net income effect is just fairly marginal, probably around $0.02 a share.

Now let me turn to the EBIT bridge and this is where we reconcile last year's EBIT of $91.5 million with this year's $91.7 million. That's an increase of $200,000. Starting with the same components that we always do volume and mix was a negative $14.5 million. Price cost –and again starting with beginning of this year price cost includes not only raw material, but also energy and freight is a positive $5.7 million.

Productivity is a positive $8.1 million and all other is a positive $0.9 million. That should add up to a positive $0.2 million. The volume mix variance of $14.5 million reflects the profit impact of the sales shortfall of $31.8 million. The majority of that shortfall was in the tube, core and paper segment and much of that is in the U.S.

There are really three elements to the profit shortfall that I need to report to walk you through. The first obviously is just the profit loss on the external sales that's profit/loss on the $31.8 million.

The second point is the profit is that lost on our intercompany sale. For example, during the third quarter, intercompany sales from our paper division – our domestic paper division to our domestic tube and core division was down around 5% and this is year-over-year. You don't see that sales shortfall because all intercompany sales are eliminated in consolidation but the profit impact falls through the paper division's earnings all the way to the bottom line.

And then the third element is mix. High strength tube and core board is generally higher margin business than our tissue and tile and edge board that replaced it. So those are the three elements that will add up to the profit impact.

The Packaging Services volume variance was negative due to volume loss due to bidding activity last year and all other was negative as well.

Now turning to price cost which includes energy and freight, that's a positive $5.7 million. This compares very favorably to the second quarter .where we had a negative $8.7 million. The price increase is especially the surcharges helped us catch back up in the third quarter.

As I said earlier, prices increased $30 million, offsetting that was material cost increases of roughly $15 million, much of which was steel and resin. Also energy and freight were $9.6 million higher year-over-year. Because of the drop in OCC prices that I mentioned earlier our average raw material costs going into our entire U.S. paper mill system declined around $7.50 a ton.

Turning to productivity, the productivity year-over-year variance was $8.1 million. That's a little less in the second quarter but generally this productivity across all segments. Comparing those with the second quarter, second quarter was $12.6 million and in this number this quarter we did experience roughly a $2 million quality claim in our metal ends business that calculates out as negative productivity.

And then other was a positive $900,000. Other is our catch-all category that includes wage increases, benefits, and other general inflationary increases. In this quarter other included $1.4 million in bad debt due to bankruptcy. Other also includes the favorable translation impact of foreign exchange and it includes about $5 million in reduced S&H spending and plant overhead saving. And these savings are a direct effect of our price controls over discretionary spending.

So that's basically the income statement. Let me turn to the cash flow for a minute. Our cash flow for the quarter was very strong. Operating cash was $166.3 million, and that compares favorably to $131.1 million last year for a difference of $35.2 million.

CapEx was $28.6 million versus $49.4 million so that compares favorably to the tune of $20.8 million. Dividends were not much different, $26.9 million in this quarter, compared with $26.4 million last year. That's a $0.5 million unfavorable.

So free cash flow if we are calculating that and we would calculate it as the net of operating cash minus CapEx, minus dividend, was $110.5 million in the third quarter versus $55.3 million in last year's third quarter. So that was an increase of $55.5 million. Now again the principle drivers are reduced capital spending, that's $20.8 million.

We did receive insurance proceeds of $26 million related to the settlement of Fox River claim and that's up in operating cash. And then net working capital was $16.8 million favorable year-over-year.

I don't usually talk about the year-to-date cash flow, but I will, because liquidity is on people's mind today. Our operating cash flow year-to-date is $310.2 million and that compares with $257.9 million last year. So that's a favorable difference of $52.3 million.

CapEx is $91.5 million that compares favorably to last year's $135 million, a favorable difference of $43.8 million. Dividend weren't much different, $79.6 million compared with $76.6 million last year. That's an increase use of cash of $3 million, so again if I am calculating free cash flow and defining it as operating cash minus CapEx minus dividend.

Free cash flow is a $139.1 million versus $46 million last year. Free cash flow was up $93.1 million. $40 million of that comes from insurance settlement year-to-date. The rest of that is from reduced capital expenditures and improved earnings. Excluding the insurance proceeds the $40 million which is already in, I still expect operating cash flow in the $400 million to $425 million range for the full year.

Let me talk about the balance sheet. For the same reasons about liquidity. Our balance sheet is as strong as it’s ever been. Debt to total capital as we calculated at quarter-end was 33.6% versus 35.8% at the end of last year and 34.2% at the end of June. Again, that's a lowest level since the early 1990s. We paid down debt as to the tune of $63 million this year.

Now, specifically to liquidity. Our total debt on the balance sheet is $786 million. $554 million of that or 70% is fixed rate debt. Our next maturity is $100 million and that's in 2010. After that we have maturities in 2013 and 2016. So our maturities are pretty spaced apart and pretty far off. $232 million or 30% of our debt is floating rate debt. $180 million of that commercial paper and $53 million is offshore bank loan.

Our commercial paper and bank debt is supported by a $500 million back-stop credit facility that runs until May of 2011. 12 banks comprise that group and the only financial covenant of any consequence is a minimum net worth test that had $400 million worth of room in the calculation.

We had no difficulty placing our commercial paper, but obviously rates have spiked over the last several months. For years, we managed our commercial paper program as a part of our daily cash management and we have rolled our commercial paper overnight. And what I think that means is that we have a steady and pretty reliable group of buyers that see our name everyday. Yesterday, we sold $183 million worth of commercial paper at 4%. And then the cash, at quarter-end, we had a $147 million worth of cash on the balance sheet compared with $80 million in last September quarter.

Now let me go to the reforecast. Our guidance for the year is in a range of $2.36 to $2.40 which means our fourth quarter guidance is $0.60 to $0.64. This means that based on third quarter actual results and our third quarter reforecast we've dropped our guidance from the previously announced $2.44 to $2.47.

There is a lot more uncertainty in this reforecast unusual. I think this means there is probably more downside risk in this forecast than upside potential. So reforecast that we pulled together in late September. Since then we see composite can volume a little bit stronger than we expected. This is the period of time when we fill up the pipeline for the holiday season so the question in front of us is will it hold up in November and December or will the consumer dramatically reduce spending?

On the other hand October volume is weak in our paper division. If that continues, there is a downside risk to the reforecast. Although the impact would probably be buffered a little bit by further reduction in OCC. So the real key to this reforecast is how well volume holds up in the fourth quarter and right now that's a bit of a question mark.

And lastly, new products, I will comment on new products. During the quarter we had $29 million in new products compared to $27 million last year. So with those comments, I will turn it over now for a question.

Question-and-Answer Session

Operator

(Operator instructions). Our first question comes from George Staphos with Banc of America. Please proceed with your question.

George Staphos – Banc of America

Hi, everyone, good morning.

Harris DeLoach

Good morning, George

George Staphos – Banc of America

First question I had, and perhaps you covered it, Charlie, but a little bit more detail perhaps it will be helpful from our standpoint. You mentioned that tubes and core volumes were not that similar in terms of the change versus the second quarter experience that you have. I mean round numbers, I think you're looking at minus 5%. What therefore was as you think about the biggest one or two sources of negative variance relative guidance in the quarter which is a volume sort out better than expected in July and August and then follow-up much more quickly and hurt your overhead absorption in tubes and core, give us a bit more detail if you don't mind? Thanks. I have a follow-on.

Charles Hupfer

Okay. I think that's exactly right. When we look at our volume, overall, it wasn't too dissimilar from the second quarter or the first quarter. As I look at monthly results I see, a drop in January, that has more or less than level, since that point in time. But clearly, we saw a fall off as in the last half of September. How much of that was due to the customers slowing down, how much of that was due perhaps to the hurricane Ike that affected us and shut down some plants. I really don't know. But we did see some volume shortfall as we got into the latter part of the quarter.

George Staphos – Banc of America

Charlie, what was the run rate coming out of September into October for tubes and core? Was it therefore more like a minus 6 or minus 7?

Charles Hupfer

In the last half it might have been minus 7, minus 8 range, but the real question is that how much of that may have come back in early October.

George Staphos – Banc of America

And you don't know that at this time.

Charles Hupfer

We don't – we haven't seen a lot of it in the first part of October. I think it may be picking up here in the second half.

George Staphos – Banc of America

The other question I had same topic. If within your consumer business you've seen any signs of the consumer further retrenching. Which product lines have been weakest as a result – you mentioned composite cans in Europe bit slow. It sounds like composite cans you have in the U.S. perhaps varying rates of volume change over the last quarter. Fill us in on what you're seeing there?

Charles Hupfer

There's a story to the European volume. That was largely a customer that change locations and shut down for a period of time for a month. That's a part of the story so. And then I think part of it is just weak volume there out of our especially our U.K. operation. But I look at the volume clearly a major – besides this one major customer that effectively shut down for a month we saw weak volume coming out of another customer and also in the U.K. as well as EuroDough, which is one of our big customers out of our French plant. So I think there is a combination of the unique circumstances plus some weakness with some customers.

George Staphos – Banc of America

U.S. hold in that pretty well on composite –?

Charles Hupfer

The U.S. held in real well. No question. I think I cited some numbers like snack volume up 16%, refrigerated dough up. The only negative was caulk cartridge was down 7.5%. I didn't mention that. And my recollection is that was even improved from the second quarter – my recollection is that was down 12%, 13%. So volume overall on the composite cans side held up well.

George Staphos – Banc of America

Thanks. I will turn it over. I will be back

Operator

Our next question comes from Claudia [ph], JP Morgan. Please proceed with your question.

Claudia – JP Morgan

Thank you very much. Good morning.

Harris DeLoach

Good morning, Claudia.

Claudia – JP Morgan

I was hoping you can talk a little bit more about the tubes and cores business in Europe. I think last quarter maybe you talked about some weakness in southern France and Italy. Just wonder sort of how that trends are in Europe, did it get worse over the quarter or there where you mentioned sort of the strength in Frontier but are there any sort of particular pockets of weakness in the western part of Europe? And then I know you have a price initiative you have unveiled for Europe. Just wondering sort of how that has been received in light of the weaker demand environment?

Harris DeLoach

Claudia, let me take the last question first. I think it's probably too early to tell how the pricing movement is taking place with this recent price increase in Europe. You're absolutely correct. We talked in the last meeting that southern France and Italy, Spain, showing some weakness. And that continues but we have seen more square of weakness in Europe, about the same timing is the U.S. normally July and August are weaker times in Europe because holiday, vacation period both those months and we normally see coming back in the September time frame, nice rebound in Europe. We did not see that and they still have particularly weak almost all over western Europe in the September time frame, particularly in the latter half of time frame. The U.S. has shown a little improvement in October over that September run rate, but I think it's anybody's guess what's going to happen there.

Charles Hupfer

And to put some numbers to that, in the second quarter we said that what we call legacy Europe was down 3.4% and this quarter it's down 4.8%, a little bit of weakness. Some of that maybe just reflect in the fact that we also closed our Spanish plant, and that would account for some little bit of that, but generally some weakness.

Claudia – JP Morgan

That's very helpful. Thanks. And then I was just hoping you could maybe just comment on implicit in your guidance, what your assumptions are for OCC prices, pulled back half a lot lately. And then if you have any thoughts on the trajectory of OCC in 2009?

Harris DeLoach

Claudia, I believe Charlie can correct me that in our guidance we have factoring in current OCC prices of $95 for the balance of the year. If there is any upside in the guidance that it would be that OCC continues to fall. I think you will see OCC prices continue to decline over the balance of the year. I think the pricing into '09 is going to be determined almost entirely by two things. That's the economy in North America, and exports to China. If I were guessing I think you will see a fairly weak OCC market at least for the next six months to eight months.

Charles Hupfer

Great. Thank you very much, guys.

Harris DeLoach

You're welcome.

Operator

Our next question comes from Mark Wilde with Deutsche Bank. Please proceed with your question.

Mark Wilde – Deutsche Bank

Good morning.

Charles Hupfer

Hi, Mark.

Mark Wilde – Deutsche Bank

I like to just follow-up on the cost side. I mean, seems to me the other places you maybe seeing some relief now are kind of things like energy and resin. Can you just comment on that?

Harris DeLoach

We clearly have seen natural gas fall, but we are hedged on about 75% of our natural gas into any given year, Mark, so we are not going to benefit to that to the extent perhaps some others might. We certainly will benefit as diesel fuel comes down on our freight side. We have not seen quite the relief that we anticipate on the resin side. It's slight a pretty high, and June and July and we felt we will start seeing some decline in August, but hurricane at least affected us. And we had difficulty getting resin now. I think it will continue to decline over the balance of the year and that will be some benefit to us.

Mark Wilde – Deutsche Bank

And just sort of back on the OCC issue. If prices stay where they are at or they go down further, how was that going to affect do you think the paperboard pricing over the next three to six months? Do you wind up having to kind of give some of that back?

Harris DeLoach

If I look at our tube pricing, Mark, probably about 55% or 60% of that is tied to an OCC indicator that reset itself at the beginning of the quarter based on the last month in the quarter. So obviously we have locked in on the price that for the balance of this year would be adjusted in the first part of the year. The paper industry as you well know as well as any others we're seeing significant cost other than just raw materials and I am talking about energy costs and others. So our hope is that we will be able to maintain the pricing that's out there.

Mark Wilde – Deutsche Bank

And then just switching gears a little bit here. Could you talk a little bit about what you think we may see in terms of kind of packaging services over the next few quarters? How do you expect that business to perform in an economic slowdown? Do you actually see more promotional activities, less promotional activities, use of point of purchase – ?

Harris DeLoach

I think I was asked this question at the – either the April conference call or either the July conference call and my answer was we have not been in this business before during an economic recession, but my folks told me normally during economic recession particularly in 2000 and 2001 that they saw increased volume as people were continuing to advertise more. We clearly have not seen that impact. We have seen weakness in that business and it's being attributed to customers telling our folks that they were basically holding on to their advertising dollars, on their promotional dollars right now. So if they are doing it right now because they have to anticipate we are going to continue to see that phenomenal working certainly through the next couple quarters.

Mark Wilde – Deutsche Bank

My last question for Charlie. If the euro stays where it's at to the $1.34 today, any idea what that will mean for you as you look into '09?

Charles Hupfer

The impact that we have in this quarter is $26 million on sales, lot of that the euro is all translation, and then of course you have to then translate sales, cost of sales, all the way down to net income, and our calculation show that it was about $2 million or $0.02 a share. So it's just a calculation so if you didn't have that that's top line calculation effect we will have it on the bottom line. It doesn't really – because we buy and sell for the most part locally, we don't do a lot of cross-border transaction it doesn't affect us economically, really just affects the reported results as they come to the translation process. So I would expect if you just said if we didn't have a – we had a flat dollar in the third quarter we would probably have $0.02 less per share.

Mark Wilde – Deutsche Bank

Very good. Thanks.

Operator

Our next question comes from Ghansham Panjabi with Wachovia. Please proceed with your question.

Ghansham Panjabi – Wachovia

Hey, guys, good morning.

Harris DeLoach

Hi, Ghansh. How are you?

Ghansham Panjabi – Wachovia

Good. How are you, Harris?

Harris DeLoach

Good.

Ghansham Panjabi – Wachovia

Looking at the consumer packaging business more specifically, Harris, I was wondering if you could just break out the different niches, composite cans, flexible packaging, et cetera, and just talk about what's happen on the competitive side? Margins on this business have seen quite a bit of an erosion over the last couple of quarters, and some of this probably is inflation-driven, but I am just curious on the competitive side?

Harris DeLoach

I don't know that we have seen a lot more competitive activity there, Ghansham, than normal – Charlie mentioned we lost a little business in the flexibles to a bid. But overall, I think no more competitive activity is normal. On the composite cans side, we continue to see good opportunity of conversion because of metal prices, and we saw conversions of coffee and anticipate that continuing. When I look at the consumer side, I think the consumer side is operating pretty much the way I would expect it to be operating. And you look at the margins, EBIT margins, in this quarter, basically they were affected by two or three things. And one Charlie mentioned the customer in the U.K. that was down from (inaudible) of a month as they moved their filling equipment and that's a largest customer, they built some inventory and obviously, you worked out inventory. They are now back up and running. The quality claim that Charlie mentioned we don't have any of these and I am pleased with that that this was an international customer and PIF had asked us to strengthen the end because they were having some issues in transit and we strengthened the end. We strengthened it to the point that was hard for anybody to open. So we obviously took back about a 1.7 million of ends, which obviously affected it. Charlie mentioned we've had several bankruptcies of customers. We had one customer in the rigid plastics that we took about $700,000 hit on in the quarter, so if you factor those things out our margins are about where they have been for the last couple of quarters. Talking about bankruptcies I will say that we are keeping a very close eye on all our accounts receivable and I believe that is the end of the quarter, we had more than 100% accrual reserves set aside for any customers over 90 days or more. So it's a concern to us, but I think we are on top of that.

Ghansham Panjabi – Wachovia

Okay. And in terms of the phenomenal free cash flow you generated, your balance sheet being in the best shape at least in since I've covered the company, clearly, the competitive environment also going to go through a distressed phase, as the credit cycle has lasted a little bit longer than anyone would have thought. What are you doing in the interim? Do you just kind of wait it out, build cash on the balance sheet or do you start getting a little bit more offensive?

Harris DeLoach

Ghansham, I think what you do right now is you just wait it out, read the signs and signals, at the right time, hopefully you hit the right time and you move it. But I think at least from our perspective it's Sonoco with a credit crisis that we have out there right now and the ability on people who need to borrow money being what it is we will be grateful in serve our cash and look for opportunities.

Ghansham Panjabi – Wachovia

Okay. Sounds great. Thanks so much.

Harris DeLoach

Thank you.

Operator

Our next question comes from Chris Manuel, KeyBanc Capital Markets. Please proceed with the question.

Chris Manuel – KeyBanc Capital Markets

Good afternoon, gentlemen.

Charles Hupfer

Hi, Chris, good morning.

Harris DeLoach

Good morning, Chris.

Chris Manuel – KeyBanc Capital Markets

Couple questions for you. First of all, if I could dissect a little further into maybe in the composite can business, where you saw a bit of a bifurcation with, you mentioned some European dough customers that were softer but in North America doing better. Is there any – I think you gave some explanation of why the European business is a bit slow in general with the customer, but with some other products, but is there anything in particular that is happening to affect the competitiveness of the product?

Harris DeLoach

Chris, there is nothing that is on my radar screen. It's still – I think it's probably just slowness in the season for dough.

Charles Hupfer

That's a through the wall operation so that's a (inaudible).

Chris Manuel – KeyBanc Capital Markets

That's helpful. Here picking up, and they are slowing down, I know there was a difference in trend. The second is if you look at last couple quarters, I know tube, core volumes have been off a bit in Europe, but if memory serves, the piece you referred to as Frontier Europe had normally been up double digit. Anything more recently in a changing trajectory in developing regions, not only in tube and core, but in any of your products, you think of developing regions?

Harris DeLoach

Charlie's looking at his notes.

Charles Hupfer

I give you the numbers, and then we can put some color to it. That you're absolutely right. We've said that in the Frontier, at the end of the second quarter, it was up 9%, Russia was up, Turkey was up 10%, and here I've said in the third quarter, that it was up 5.3% and Turkey was up 10.7%. These are pretty small numbers, so I don't think there is any significant change that I heard of in our –what we call Frontier Europe businesses in terms of major shift.

Chris Manuel – KeyBanc Capital Markets

How about any of the other products lines as you look into Brazil, as you look into Asia, as you look into – whether consumer, whether it's any of product line?

Harris DeLoach

I think Charlie mentioned, Chris, is that we have seen slowing in tube and core in Europe and Asia as well. So obviously some slowing there. On the consumer side, the composite can side, the opportunities in Asia, continue to be very strong and there are certainly on the international opportunities that we are working on now on the private and performance side, moving folks from tin into composites. So it still seems to be very good opportunity.

Chris Manuel – KeyBanc Capital Markets

Two last questions. The first is now every few years you typically take a step back and review the footprint for and to kind of right size it with (inaudible) for end markets and migration et cetera. With some of the continued slowing volumes here in North America and some further shift in Europe, is there – what is the effect or do you feel there is a need to review the footprint again for any potential restructuring type activities?

Harris DeLoach

Chris we are always looking at the footprint and that is not necessarily something that we do in times of slowdown. We look at it at all times, as I think you do know. But clearly as we see these volumes slowdown around the world in some of our businesses, we are questioning what the footprint will be and what is the affordable fixed cost that we have to add to maintain the kind of margins that we want to generate the value for our shareholders and you know we are looking at that affordable fixed cost as we speak and I would anticipate something to in fact come out of it.

Chris Manuel – KeyBanc Capital Markets

That's helpful and then the last question I had is as we – it kind of come back in connection to last question with free cash flow. On one hand you have indicated to us that your – in the acquisition pipeline is you are looking at lots of different things, and separately you have told us that if you didn’t find anything by year-end you may look at a share repurchase. How do you – does the credit situation change that i.e. it makes you more inclined to hold the cash as opposed to do share repurchase this year.

Harris DeLoach

I don’t want to speculate on what we might do from an acquisition standpoint or buying back shares, but I will say like I did right now in our opinion it is not a bad time to have cash sitting around. So you can read what

Chris Manuel – KeyBanc Capital Markets

Fair enough. Thank you gentlemen.

Harris DeLoach

Thank you Chris.

Operator

Our next question comes from Tim Burns with Cranial Capital. Please proceed with your question.

Tim Burns – Cranial Capital

Hi Harris and Charlie.

Charles Hupfer

Hello.

Harris DeLoach

Hello Tim. How are you?

Tim Burns – Cranial Capital

Nice to hear your voices. I missed part of the call. I apologize. The question – one of the questions I had was do you see the composite can in the states picking up any volume based on the environment and the green footprint type of thing?

Harris DeLoach

Tim absolutely, I mean we have converted two of Kraft's coffee metal into composite and one of the things they wanted was approve that this was totally recyclable and green and they actually used that advertisement on the label. So, we are seeing a lot of opportunities in the composites, A, we call this sustainability, and B, which probably drives the cost differential which continues to widen between composites and metal.

Tim Burns – Cranial Capital

Got you. Got you and the other question I had was if you guys could get the Cinnabon account. I’ve got a feeling your volumes would rise?

Harris DeLoach

It is a joke.

Tim Burns – Cranial Capital

I mean that is like a dinner. It is like a steak, I don’t know if you guys had that one but –

Harris DeLoach

I better have one.

Tim Burns – Cranial Capital

You got to try one.

Harris DeLoach

I will do that for you too.

Tim Burns – Cranial Capital

You can call home to your wife and tell her not to cook dinner tonight?

Harris DeLoach

Shall I do it tomorrow night?

Tim Burns – Cranial Capital

Absolutely.

Harris DeLoach

Okay.

Tim Burns – Cranial Capital

The other question I had was you know you have got this one phase of the customer strategy and you know I have seen you get into like personal care containers and I – you know what I have read about your strategy is you know we are willing to provide services and products of a wide range that benefit our customers, I mean how far does that go? Are you willing to go even you know deeper or further afield to make you know one of your many, many blue-chip customers happy?

Harris DeLoach

No, we have the portfolio Tim that we need at this point and it is working quite well. I have a chart that I have used on many presentations. It shows how we have grown the business through this strategy across the numerous portfolios and I will be happy to share it with you but it is going quite well and I don’t see the need right now to extend the value offering.

Tim Burns – Cranial Capital

And I heard, again I may have missed this. So, I apologize, but I heard that there was a loss of flexibles in a bidding process, but generally speaking how do you feel about flexibles, has it made more progress, is it closer to your targets?

Harris DeLoach

It is certainly performing much better from an operational standpoint and from a P&L bottom line standpoint then it was over the past year and a half and basically nothing but improving conditions. I frankly don’t even recall who the bidding contest was with, but I think we will continue to see flexibles improve as it has this year. I think there will be some exiting new business that I can talk about in December that I cannot talk about today, but basically we feel very good about it.

Tim Burns – Cranial Capital

Great and one more piece of advice, when you have the (inaudible) make sure you are sitting down.

Harris DeLoach

I will certainly follow your good advice Tim.

Tim Burns – Cranial Capital

Hi Harris and Charlie have a good one.

Harris DeLoach

You bet.

Operator

You have a follow up question from Mr. George Staphos of Bank of America. Please proceed with your questions.

George Staphos – Banc of America

Thanks everyone. As far as flexible packaging goes and obviously you have improved the performance relative to last year which was obviously a very tough year for the business Harris. Do you see a need to invest any more within the business or invest at a higher run rate then what you have seen in 2008. Can you give some idea in terms of the level of invested capital you have in the business currently and are you happy with the return on capital within flexible packaging?

Harris DeLoach

Well George you asked me about 4 questions as you normally do which is fine. First of all, I do not see the need to invest significant amounts of capital in that business right now. We have – we have improved the efficiency of the equipment and the changeover times and so we have basically created the capacity that I think we need particularly on the flexible side for the next several years. So the answer to that is no. We – I don’t know, I just keep repeating myself we have seen improved performance over there. Is it returning the kind of returns on that capital and I expect them to get? No, it is not. Am I satisfied with the returns today? No, I am not.

George Staphos – Banc of America

Is it earning cost to capital Harris maybe –

Harris DeLoach

It is on the cost to capital George.

George Staphos – Banc of America

Okay. Now switching to the bottles business, you know we have been hearing some of the early reports discussion about customers pushing backwaters and taking inventories down and certainly not (inaudible) given what has been going on the last several week and months. Have you seen any kind of similar developments within your business and with some of your bigger customers. If you had mentioned earlier I had missed it.

Harris DeLoach

George, I think we have only seen that with one customer and it is not widespread but they have – I think there has been some destocking at that particular customer.

George Staphos – Banc of America

Is it a big customer?

Harris DeLoach

It is not a small customer. But that is one of the things that I think is Charlie and I both pause in our forecast for the month – for the quarter and that is I think Charlie said the consumer side right now the run rate particularly in composites is what we would expect it to be and normally we see that run rate continue up until the second week of December. We are more conscious this year because I think there is going to be reluctance on peoples part to build a lot of inventory for the holiday season in anticipation that the consumer might not try as much and so that is the real question for us in this quarter as Charles said one of them.

George Staphos – Banc of America

I know we will talk about this in December, but as you think of 2009 what do you think will be the levers at the disposal to – or just trendwise that will help you grow earnings or EBIT next year or is that perhaps understandably so not necessarily on the horizon?

Harris DeLoach

I guess we are going into the budget – we haven’t started our budget process for 2009 and we will start them in a couple of weeks but clearly I think volume next year is going to be issue and the economy is going to be an issue. I think the levers that we will pull will be on the productivity side, which I currently anticipate our productivity numbers to be as good next year as they have been in the last several years and we will look at the cost side. We will prudently use cash as appropriate to improve those numbers either from acquisition or otherwise, but I think those are the kind of levers that we will pull next year George.

George Staphos – Banc of America

Okay, well that is relatively well I would think. Thanks guys I will turn it over.

Harris DeLoach

Thank you George.

Charles Hupfer

Thank you.

Operator

There are no further questions in queue at this time. I like to turn the call back over to management for closing comments.

Charles Hupfer

Well, thank you very much and again let me again thank all of you for joining us today. We certainly appreciate your interest in the company. Please reserve the date of Friday, December 5 to attend Sonoco’s annual breakfast meeting with financial community in New York. You are invited to join our senior management team for an operating and financial update including a review of new products like Harris alluded to. The breakfast meeting will begin at 7.30 a.m. in the Grand Hyatt Hotel Manhattan Ballroom. Our presentation will begin at 7.50 a.m. followed by your questions. Invitations will be sent out next week and we ask that you RSVP in advance so that we have an idea of how many people will be attending and we certainly look forward to meeting with you in New York on December 5. As always if you have any questions please don’t hesitate to give us a call and thank you for attending.

Operator

Ladies and gentlemen this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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