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Owen-Illinois, Inc. (NYSE:OI)

Q3 2009 Earnings Call

October 29, 2009 8:30 am ET

Executives

Edward C. White – Senior Vice President and Chief Financial Officer

Albert P. L. Stroucken – Chairman, President and Chief Executive Officer.

John Haudrich – Vice President Investor Relations

Analysts

Christopher Manuel – KeyBanc Capital Markets

George Staphos – Bank of America/Merrill Lynch

Ghansham Panjabi – Robert W. Baird

Timothy Thein – CitiGroup

Mark Wilde – Deutsche Bank Securities

Albert Kabili – Macquarie Research Equities

Claudia Shank Hueston – JPMorgan

Alton Stump – Longbow Research

Richard Skidmore – Goldman Sachs

Joseph Stivaletti – Goldman Sachs

Chip Dillon – Credit Suisse

Peter Ruschmeier – Barclays Capital

Operator

Good morning, my name is Angela and I will be your conference operator today. At this time I would like to welcome everyone to the OI Third Quarter 2009 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question-and-answer session. (Operator Instructions)

Thank you, I would now like to turn the call over to Mr. Ed White, Senior Vice President and Chief Financial Officer. Please go ahead sir.

Edward C. White

Thank you Angela. Good morning and welcome everyone to OI’s third quarter 2009 earnings call. I am joined today by Al Stroucken our Chairman and CEO; John Haudrich, Vice President of Investor Relations and several other members of our senior management team. Today we will discuss key business developments in the third quarter, review our quarterly financial results and discuss the trends affecting our business. Following our prepared remarks we’ll [host] the question-and-answer session.

Presentation materials for this earnings call are being simulcast from the Company’s website at www.O-I.com. Please review the Safe Harbor comments and our use of non-GAAP financial measures included in those materials. The financial results we are presenting today relate to adjusted net earnings, which exclude certain items that management considers not representative of ongoing operations. A reconciliation of GAAP to non-GAAP earnings can be found in our earnings press release and in the appendix to this presentation.

I will now turn the call over to Al.

Albert P. L. Stroucken

Thank you Ed and good morning. We are pleased with our third quarter results, especially in light of today’s challenging marketplace. As you can see on chart two, our adjusted net income was $0.95 per share consistent with the second quarter and up from $0.90 last year. In fact our third quarter earnings reflect the first year-over-year improvement since the global recession began to impact our business in the third quarter of 2008.

Our improved financial performance reflected our ability to adapt to a rapidly changing marketplace. We focused on our supply chain to match supply with lower demand, reduced inventory and improve efficiency. We maintained our margin recovery efforts and we continue to deliver savings from our strategic footprint alignment initiatives.

Shipments in the third quarter were down 7% from the prior year, a considerable improvement from declines we experienced in the first half of 2009. Furthermore, shipments were down only 5% when you exclude South America, which was still experiencing double-digit volume decline. Total shipments were flat with the second quarter as gradually improving market conditions offset the typical seasonal shipment decline between the second and third quarters.

Overall, we believe demand patterns in most regions are now in line with underlying consumer trends, which are still down modestly from the prior year. Temporary production curtailments continued to counterbalance lower demand and avoid unnecessary and costly inventory buildup. In fact our inventories in ton at the end of the quarter, were down 9% from a year ago. We also have made a supply chain improvements, or we also have made supply chain improvements a top priority.

The savings generated by the streamlining of our warehouse and delivery processes, for example partially offset unabsorbed fixed cost associated with the curtailments. Our price over volume strategy, which has successfully repaired our profit margins, contributed more than 4% of sale in the third quarter. This year-over-year improvement was consistent with the second quarter.

Our strategic footprint alignment initiatives is also critical to maintain our margins and repair some of the margins even further. Closing high-cost operations and shifting that business to more efficient operations has reduced fixed costs by $104 million year-to-date. While our initial focus was on North America and Europe. We are now extending our footprint efforts to South America.

We generated significant free cash flow in the third quarter, as a result of our strong financial result and aggressive working capital management. Consistent with prior year trends and the planned deferral of CapEx to the second half of this year we expect high levels of capital spending in the fourth quarter.

Looking ahead, as market conditions gradually improve fourth quarter shipments should be down only modestly compared to the prior year, nevertheless temporary curtailments will continue and we expect to reduce inventories as we focused on further working capital opportunities.

Average selling prices should be up from the prior year, but to a lesser degrees than in previous quarters as quarterly price adjustments for energy costs are now more prevalent in our contract basis. Input costs should remain stable, our footprint initiatives will deliver continued year-over-year benefit, but additional South American realignment activities will offset some of these savings in the fourth quarter.

Finally, fourth quarter results will be impacted by a number of non-operating items that Ed will discuss further. Overall, our Company performed well in the third quarter as we further improved margins, generated significant cash flows to fund future growth and continued to improve our already strong financial position.

Now I will review our performance by region. On chart three, you will see segment operating profit for each of our four regions. To help with the year-over-year comparison we also included third quarter 2009 profit adjusted for changes in foreign currency. All regions expect South America posted improved year-over-year operating profit in the quarter.

Our Company-wide segment profit margin reached 17% and represented our highest quarterly margin in over a year. Our European results continued to improve reflecting better mix and the more efficient cost profile, despite lower volumes. Shipments were down modestly from the prior year consistent with consumption trends in the markets we serve. Demand for wine and spirit containers was down only slightly from the prior year. Beer shipments saw a greater decline, in part because many of our customers are multinationals with the significant amount of exports from Europe, which remained under pressure due to the global recession.

As a result, we continued our strategy of temporary production curtailments. Consistent with the second quarter favorable price and mix increased sales compared to the prior year quarter. Lower energy cost in the third quarter contributed to modest net deflation across Europe. As part of our footprint initiative we closed our plant in Finland and ceased production at a facility in France.

Europe represented nearly half of our quarterly footprint benefit in the third quarter. North America segment profits improved over the third quarter 2008 primarily due to additional footprint savings and cost deflation. Like Europe, North America’s volumes were down modestly from the prior year. This was primarily a reflection of lower consumption trends, especially in the premium beer and wine segments.

Our price over volume actions in 2008 also contributed to lower shipments. Temporary production curtailments in North America continued to offset lower demand. Selling prices trended down from the second quarter due to quarterly price adjustments that passed through recent energy deflation to our customers.

North America reported net cost deflation as lower energy prices more than offset inflation in all other category. Footprint initiatives again generated year-over-year benefit in the quarter although comparative savings in future periods will decline as we lap our 2008 planned closures. Lastly, we are entering the final stages of contract negotiations with several of our larger North American customers. We expect to achieve our margin objectives including provisions for more rapid pass-through of volatile cost components like energy. While these new agreements may have some impact on volumes we feel that they will appropriately balance other important factors, such as margins and supply chain opportunity. The net result should provide a considerable benefit to future earnings.

Our South American operations are just starting to see signs of recovery from the global recession. While profits were down compared to 2008 they improved slightly from the second quarter. South American shipments declined from the prior year and significant curtailment was required.

Lower volumes reflected a common recessionary trend in which customers temporarily extends the useful life of the returnable and refillable bottles that are prevalent in the region. Fortunately, demand for returnable bottles has recently started to improve. Further the agro export business in Peru and the spirits business in Brazil performed much better on a year-over-year basis, in the third quarter than in the second quarter.

As a result, volume declines moderated during the quarter to the point where they were down in the low teens by quarter end. The increased prices in South America to offset continued cost inflation especially in Venezuela. Building on the success of our footprint activities in North America and then Europe, our South American management team has now identified several footprint opportunities of itself.

As a result we expect to close additional furnaces in this region and move a significant number of machine lines to increase furnace utilization. This will allow us to maintain the same production capabilities in our South American operations, but with a more efficient cost profile.

A number of these actions have already commenced, including the closure of one furnace in the third quarter and our margin in the region during the quarter, of course was impacted by five percentage points, as we remitted cash from Venezuela to mitigate exposure to the potential devaluation of Bolivar. Despite lower shipments and Venezuelan currency charges, South America continues to have the best margin of all our regions.

Asia Pacific's third quarter showed promising results as profits rebounded from the second quarter and improved on a year-over-year basis. These segments like beer and wine in Australia and New Zealand have started to recover and we are seeing even stronger growth in China. As a result shipment levels were on par with third quarter 2008 levels.

Prices have improved from the second quarter while inflation was modest. We also saw a decrease in maintenance and freight costs from the second quarter as two furnace rebuilds last quarter were completed and the factories were back on line. Overall, we are very pleased with the progress of each of our regions, in this challenging marketplace. And we are confident that our strategies will continue to drive improved financial performance over the long-term.

I will now turn the call back over to Ed.

Edward C. White

Thanks Al. Lets move to chart four, which illustrates our year-over-year reconciliations for sales, operating profit and EPS. We will start with revenue. Segment sales declined from approximately $2 billion in the third quarter of 2008 to $1.9 billion this year. The 7% decline in glass shipments impacted revenue by $150 million, improved price and mix increased sales by $91 million or more than 4%. And finally a stronger dollar resulted in lower sales due to foreign currency translation.

Moving on to our segment operating profit reconciliation, third quarter profit was $317 million up from $288 million in the third quarter last year. Lower shipments reduced operating profit by $57 million. As I mentioned improved price and mix increased profits by $91 million.

During the quarter, the dollar was stronger on average than it was a year ago and foreign currency translation was a $10 million headwind, on a year-over-year basis. For your reference a chart illustrating average foreign currency exchange rate, by quarter is included in the appendix to this presentation.

Manufacturing and delivery costs decreased $24 million compared to the prior year. This reconciliation line reflects an $85 million benefit due to cost deflation, footprint initiative savings and lower warehouse and delivery cost. These benefits were offset, in part by $61 million of higher year-over-year unabsorbed fixed costs, related to temporary production curtailments.

Other non-operating costs were $51 million higher compared to last year, reflecting currency exchange losses in Venezuela. On an after tax basis the net impact was $10 million. On EPS basis our adjusted net income was $0.95 per share in the third quarter of 2009 up from $0.90 last year. At the operations level, earnings were up $0.20, primarily due to changes in volume, price and mix and manufacturing cost.

However, there were a number of non-operating items that negatively impacted earnings by $0.15. These items included the foreign currency charges in Venezuela that we just mentioned. Higher corporate cost primarily due to the swing from pension income at 2008, to pension expense in 2009. This reduced earnings $0.05. And finally, our effective tax rate, which excludes the tax effect for items listed in Note 1. Was approximately 31% compared to 26% in the third quarter last year.

A higher tax rate this quarter reduced EPS by about $0.09, reflecting a change in earnings mix and a discrete tax event in Europe. The company expects its full year effective tax rate will approximate 26% to 27%, which is higher than our previous expected range of 24% to 25%.

Chart five, expands on a discussion on cost trend. We realized net deflation of $9 million in the third quarter, as lower energy cost more than offset slight inflation in all other cost category. As you may remember from our second quarter call, we outlined an expected range of inflation for 2009 in $75 to $100 million. Now that we have third quarters of way through the year and energy prices have stabilized. We expect inflation to come in at the low end of our estimate for the full year.

In the graph on the right side of the chart, we show the year-over-year benefits from our strategic footprint initiative. Since 2007, we have closed or permanently ceased production of 18 furnaces, including three in the third quarter. Year-to-date our strategic footprint alignment initiative has saved $104 million compared to the same period last year.

As Al mentioned, we are now lapping some of North American footprint activity. As a result year-over-year third quarter benefits from these actions totaled $34 million down slightly from the second quarter. The South American footprint initiative was the largest component of the $58 million third quarter Note 1 restructuring charge.

In addition to any future Note 1 charges, we expect to incur $10 to $12 million of machine relocation expense in South America during the upcoming quarter. As a result, we anticipate fourth quarter net footprint benefits to approximate $20 million.

Finally, the third quarter benefited from lower warehouse delivery and production cost as compared to prior year. We don’t expect these year-over-year savings to continue in the fourth quarter, as we took swift corrective action last fall to reduce inventories and improve our supply chain efficiency in the wake of the sudden drop in demand. Chart six, illustrates our year-over-year free cash flow reconciliation. In the first nine months of 2009, our free cash flow was actually up compared to the same period last year.

I think this is remarkable given the fact that we’ve had a significantly lower shipment. It demonstrates our ability to adapt to a rapidly changing marketplace especially in terms of working capital management. Year-do-date we’ve reported positive free cash flow of $386 million compared with $342 million in the first nine months of last year. The red bar show decreases in components of free cash flow compared to the prior year, while the green bars show increases.

Starting with the red bars, while our third quarter earnings improved over the prior year, our year-to-date earnings are still down from last year and reflected the very challenging market conditions in the first half of this year. Depreciation was down due to the impact of foreign currency translations rates, and a reduced manufacturing footprint. Restructuring payment were nearly $15 million higher due to increased footprint spending this year.

Looking at the green bars, working capital continued to be a strong source of cash. Our efforts to reduce production and to lower inventories generated a $203 million improvement over the first nine-months of 2008. Asbestos spending was down $18 million year-to-date during the same period, capital expenditures were $45 million lower. Yet, we still expect full year 2009 CapEx to exceed 2008 levels.

Other operating cash flow items, defined in the footnote at the bottom of the chart, provided $59 million and were principally driven by lower net interest in tax payment in the first nine months of this year. Let’s move from free cash flow to our balance sheet on chart seven. Debt at September 30th was just over $3.7 billion up slightly from the second quarter. As of the third quarter we improved our debt to EBITDA ratio, which is now 2.3 to 1. Our global revolving credit facility remains untapped, giving us additional borrowing capacity of approximately $760 million. On September 30th cash on hand exceeded $1 billion, which is an increase of $340 million and reflects considerable positive free cash flow in the third quarter. Our significant cash balance is not only prudent given today’s economic uncertainty, it securely positioned our Company to pursue its strategic priorities.

Last quarter we discussed our cash position in Venezuela and the possible use of the parallel exchange market to accelerate the remittance of earnings back to the United States. To avoid increased exposure to Bolivar, the company began the process of exchanging Bolivar for dollars in the parallel market. And we recorded a net foreign currency exchange loss of $10 million after-tax. While we will continue to pursue currency exchange at the official rate, we will also keep using the parallel market. As a result, we anticipate exchange losses in the fourth quarter. Please note inflation is accelerating in Venezuela, this could impact how companies would be required to translate their financial results.

However, since we are already remitting earnings using the parallel market, we would not expect a change in the translation method to have any additional material impact on our Venezuelan net earnings. Shifting to capital and restructuring expenditures. Year-to-date capital spending was $194 million and our full year CapEx forecast remains up to $440 million.

As Al mentioned earlier, we deferred some capital spending into the back of this year given market conditions earlier in this year. Furthermore, fourth quarter is typically our highest CapEx period as we take advantage of seasonally slower demand to conduct routine maintenance and upgrade our manufacturing facility. Therefore we expect significant capital expenditures in the fourth quarter.

With regard to restructuring, year-to-date payments were $43 million and full year 2009 restructuring payments may approach $100 million as we ramp up our realignment efforts in South America. Now turning to chart eight, it presents our business outlook, including the key business drivers for earnings and cash flow. The arrows illustrate the anticipated favorable, unfavorable or neutral impact on fourth quarter 2009 earnings. On a year-over-year basis as well as on a sequential quarter-to-quarter basis.

First, we expect shipment will be modestly below prior year, principally due to soft South American demand but overall shipments will reflect continuing economic recovery. Now, they should decline from the third quarter but that is due to typical seasonal trends in our business, as volumes usually drop 3% to 5% between the third and fourth quarter.

Next unabsorbed fixed cost penalties, due to temporary productions curtailment will continue until demand returns to prior year levels. Even that expected shipment trends and a continued focus on inventory reduction we expect temporary production curtailment will remain high, and will be up sequentially due to the seasonality of our business.

We expect price and mix will be up on a year-over-year basis, but to a lesser degree than the past few quarters. As quarterly price adjustment for highly volatile costs like energy, which has been deflationary, are becoming more prevalent in our contract base, input costs should remain flat on a year-over-year basis primarily due to the net benefit of lower energy. But on a sequential basis spending will be up in the fourth quarter, in part due to the costs associated with year-end maintenance and the high level of the capital project.

As I mentioned, compared to footprint realignment savings should decline sequentially due to machine relocation costs in South America. However, the total footprint benefit should approximately $20 million on a year-over-year basis.

Finally, we want to update you on a few non-operational items. First, corporate costs will increase from the prior year due to higher pension expense and the absence of currency hedge gain from last years fourth quarter. As we’ve mentioned before full year 2009 corporate cost should range between $70 million and $80 million compared to the $49 million year-to-date number.

Next, we’ll expect to continue to exchange Bolivar at the parallel rate in Venezuela. Also interest expense should be up from last year due both higher debt levels and higher interest rate. And finally, our tax rate in the fourth quarter should be significantly higher than our prior year quarterly rate of 17%.

In total, the fourth quarter operating profit should exceed the prior year quarter, consistent on a dollar basis with the improvement we achieved in the third quarter as illustrated earlier on chart number four. However, the significant non-operating items I just outlined will impact bottom line results by $0.30 per share in the fourth quarter. Now having said this, the extent to which our operating profit improvement offset non-operational cost will be influenced by numerous factor, in particular, how quickly demand for our products recover, which continue to be unclear as it has been all year.

Now I will turn the call back over to Al for his final remarks.

Albert P. L. Stroucken

Thanks Ed. As we look back over the last 12-month, we are encouraged by our progress. Our team has done an excellent job improving our margins over the past year despite the recession. Our net earnings have improved consistently and in the third quarter exceeded prior year results for the first time.

After facing an unprecedented decline in demand, our shipments no more closely reflect consumer consumption trends, which implies that our customers extensive inventory adjustments are largely behind us. Throughout all of this we have managed our working capital levels to all-time lows and have improved our free cash flow quarter-by-quarter.

What this means is that we are well positioned, to take advantage of market opportunities that will emerge as the economy recovers. We have the resources to participate in market growth and to pursue strategic and profitable expansion opportunities as they evolve. O-I has emerged an even stronger company today than we were a year ago. In spite of the challenging market conditions we experienced.

This is a tribute to the 23,000 people who work here and kept focus on our core franchise. Now I will ask the operator to open the line for questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) And your first question is from the line of Chris Manuel with Keybanc.

Christopher Manuel – KeyBanc Capital Markets

Good morning.

Albert P. L. Stroucken

Morning Chris.

Christopher Manuel – KeyBanc Capital Markets

Congratulations on a strong quarter, couple questions for you. First let me start with some thoughts as we began to look to 2010 you’ve made some incredible progress here through the year and the biggest differential or one of the biggest differentials is as you look at cost price and how favorable that’s been this year. With your first pass at looking at 2010, are you anticipating that you will be able to keep that neutral or would you anticipate that could be a potential headwind or even more favorable for you next year?

Albert P. L. Stroucken

I think overall our strategy has been very careful over the last three-years and that is margin repair, margin expansion. And we are driving a lot of activities in the organization related to productivity and so on, that will even in an environment where inflation is no longer the driver for prices allow us to get margin expansion. I think what we of course will not see is the rapid escalation that we saw over the last three-years which included quite a lot of repair need as well and backlog. But I am very confident that with the steps that we are taking with our footprint alignments and so on and just assuming a normal economic recovery, we will see quite a significant benefit from these cost saving steps that we have taken over the last couple of years.

Christopher Manuel – KeyBanc Capital Markets

Okay. And then along those lines, my second question was the volume trajectory has seem to improve very nicely sequentially quarter-to-quarter-to-quarter when looking at on a year-over-year basis. At some point it would appears though with, with some of these regions I think you mentioned Asia-Pacific getting to flat, seeing some improvement in South America as well. That at some point the whole company, you will turn flat and likely, at some point early next year actually return to positive numbers. Does that kind of mesh with, with what you are thinking is or how are you anticipating the volume trajectory plays out the next couple of quarters with the substantial improvement you are seeing sequentially?

Albert P. L. Stroucken

Chris, I think what we are seeing is still a variation between what logic would indicate and what people are willing to commit to and what people are willing to project. At this point in time what we are seeing in our customer base is a very high reluctance to make any predictions for an increased volume requirement for the coming periods, whether in short-term or long-term. Nobody really at this point in time is willing to be optimistic. It’s almost seen, a little bit as being optimistic is not very intelligent at this point in time. But I think if you look at the basic underlying trends that we already have seen this year and that we would typically see in an economic recovery, it’s quite obvious that we will somewhere cross these differentials to the positive, somewhere in the first half of next year. Now I would personally think that most probably because of the heavy impact that the pipeline cleanout had in the first quarter and the second quarter that most probably is likelier to happen in the first quarter than in the second quarter.

Christopher Manuel – KeyBanc Capital Markets

Okay. That’s helpful. Thank you.

Operator

And your next question is from the line of George Staphos with Bank of America and Merrill Lynch.

George Staphos – Bank of America/Merrill Lynch

Thanks. Hi everyone. Good morning. Thanks for the detail. I just want you to try to drill down a bit on the fourth quarter, realizing that volume will be the key driver of whatever EBIT improvement you see. Given, as you are looking at the world today, it would suggest EPS that is roughly flat to below of last years level, would you agree with that given the non-operating or below the line items as you see them at the present time.

Albert P. L. Stroucken

No, George I think we have given as much detail as we can for people that follow the company to draw their conclusions, as you know from the past we really don’t give specific guidance. But I think with all the components we have discussed I think it’s fairly simple to come to a reasonable conclusion as to what the fourth quarter is likely going to be.

George Staphos – Bank of America/Merrill Lynch

Okay, Al, I understand, I just trying to get that on the record for the conference call. In terms of the realignment, and what you trying to accomplish in South America, can you give us a bit more color in terms of where machines are moving currently and back to Chris’s question, is there any way to ballpark what kind of impact that could be for 2010, and with all supply chains I should say inventory reductions that you have underway in the strategy why are you adding a ware house in Windsor? Thanks very much.

Albert P. L. Stroucken

Okay. Well with regard to the supply chain activities what we are looking at is really, where we can take cost out of the system and where we can become much more productive. And the warehouse in Windsor for instance gives a clear payback, very short-term pay back period because we are using outside warehouse facilities, which are fairly costly. And so the payback there if I recall correctly is less than two years or something like that. So that was a pretty good investment to make and it will give us a very good return. With regard to Latin America, the issues that we are dealing with at this point in time are really a logical sequence because we were focusing on the areas that had the greatest need and that had the greatest opportunity first for footprint alignments. You know that Latin America always has had a much higher margin than the other regions. But it’s quite obvious that despite a high margin, there still are significant opportunities for cost benefits and for productivity improvements and that’s why we are making these changes. As we are closing some of the furnaces it’s also logical that given the fact that Latin America is a growing market and does not have, in the long-term, at least, mid and long-term, it is not going to be a market where we can just stay with existing installed capacity. We’ve got to be able to pull more out of the remaining furnaces and that’s why we have to move machines to those furnaces to be able to basically get more bottles out of the same installed base that is left at that point in time. And that of course, will lead to cost benefits and cost improvements that we have not seen in the past.

Edward C. White

And George, it's basically across the big three. Venezuela, Columbia, Brazil are the target because they're the big three operations down there.

George Staphos – Bank of America/Merrill Lynch

Okay, thank you.

Operator

And your next question is from the line of Ghansham Panjabi with Robert W. Baird.

Ghansham Panjabi – Robert W. Baird

Hi, guys good morning.

Albert P. L. Stroucken

Good morning.

Ghansham Panjabi – Robert W. Baird

Al, in your prepared comments, you kind of hinted that you would cede some, you may cede some market share in the U.S. as part of your contract [re-negotiations]. At least one a competitor seems willing to do the same. What’s your sense on where capacity utilization is in North America and is it fair to say that, you would anticipate closing some facilities if did you cede some share? Thanks.

Albert P. L. Stroucken

Well, I would say that overall, based on the statistics that are being published in the United States, it's obvious that, overall volume this year has been running somewhat of like 4% or 5% below the previous year which I think, given the steps we have already taken in the past and some of our competitors have taken in the past, would indicate that capacity utilization is still added fairly decent rate. It’s not at maximum rates but certainly there is not a lot of free abundantly available capacity there. I believe that the issues that we’re facing at this point in time are more related to the overall demand profile that some of our customers see. As I said earlier it’s very difficult for them to make positive projections for the next year. So there is a basic underlying assumption that is flattish at this point in time from their perspective. But I don’t think that, that necessarily is true, given the economic realities we will see next year with a economic improvement.

I would believe that, the overall supply demand situation in the United States, at this point in time, is fairly balanced. I think that with increased demand, that supply demand situation may become a little bit tighter than we have in the past We too, of course in preparation for these discussions and negotiations have started already 2.5 years ago with our footprint alignments and we too in the course of this year have made a further or have notified our people in one plant in particular that we will have additional curtailments as, an outcome of these negotiations to make sure that our cost base stays balanced with our contractual obligations.

Ghansham Panjabi – Robert W. Baird

Okay and Ed, I'm sorry if I missed this but what drove the swing in the minority interest line?

Edward C. White

Well if our South American operations are making less money then our minority partners are making less money.

Ghansham Panjabi – Robert W. Baird

Okay, thanks.

Operator

And your next question is from the line of Tim Thein with CitiGroup.

Timothy Thein – CitiGroup

Good morning. The first question is on the sales volumes projection or outlook for the fourth quarter? Is that kind of a same store basis meaning you have less capacity than did you a year ago? Does that reflect for that? I'm just trying to get at the outlook in terms of throughput through the existing plants?

Edward C. White

You are right Tim it's basically, sales will be down from prior year slightly and we also had fewer factories or fewer furnaces this year than last year so, it’s sort of matching up that way.

Timothy Thein– Citi Group

Okay and then Ed on the M&D line, if you kind of break through the components, I think you'd call that warehousing and delivery as one I'm sure there are other components in there besides the deflation and the footprint realignment, and then of course the downtime but why that was a good sized number if you kind of back into it warehousing and delivery. Why would that go against you or be less of a help in the fourth quarter I missed that?

Edward C. White

In the fourth quarter what I was saying is we are going to have more expense spending on repairs and maintenance because we deferred some of that in the first half of the year. So we are going to have the high capital projects and so there would just be more spending going on in the factories.

Timothy Thein– Citi Group

Okay thanks a lot.

Operator

And you next question is from the line of Mark Wilde with Deutsche Bank.

Mark Wilde – Deutsche Bank Securities

Good morning.

Albert P. L. Stroucken

Good morning Mark.

Mark Wilde – Deutsche Bank Securities

Ed and Al, I wondered if you can just give us some sense of what you might be thinking about for 2010 volume and then I wondered if you could put any more color on what you think the volume impact maybe here in North America from the contract fallout? And also I noticed awhile back that the champagne producers in France are really cutting back on the production those are pretty heavy bottles. Is that going to have any significant impact on you guys?

Albert P. L. Stroucken

Well let me take the champagne part first. It's quite obvious that the champagne producers are cutting back on acreage that they are going to till the next year and that they're going to cultivate next year because of the inventory that has build up in the course of this year. I think we already have seen significant volume drops in the course of this year, which were really the pipeline effects. So I don’t think we will see further deterioration of that segment. We might possibly even see some improvement, but the underlying production of champagne has been cut back to preserve pricing and margins for the champagne producers. I don’t think it’s going to have a dramatic impact in 2010 over 2009 because I think we saw most of that already occurring in 2009. With regard to the overall volume question that of course, is the $10,000 question that everybody is wondering about for next year, and Mark I can only reiterate what I said earlier. I think logic would dictate to that, we will see a recovery from the overall average that we have seen this year because we have the first and the second quarters being so significantly below any trends that we’ve seen in the past. Now how far it will then improve from the run rates that we have at this point in time is really the basic underlying question. But I’d say overall, it most probably is going to look a bit more positively than we’ve seen on the average for this.

Mark Wilde – Deutsche Bank Securities

Okay. And then just as a follow-on. Can you give us some sense of what you are assuming in the fourth quarter in terms of an FX effect. It seems like should actually be tailwind for you as we move into the fourth quarter.

Edward C. White

Hi, Mark if rate stay where they are now, it would be a modest tailwind in the fourth quarter.

Mark Wilde – Deutsche Bank Securities

Okay, is the modesty, in part, an effect of some hedging that you got in place, I mean if you didn’t have hedges would it be a larger impact?

Albert P. L. Stroucken

Well I think if you combine the Venezuelan impact, which also is a currency impact with the benefit that we see from the other regions that’s where it becomes modest.

Mark Wilde – Deutsche Bank Securities

Okay. Got it. Thanks.

Operator

And your next question is from the line of Al Kabili with Macquarie Research.

Albert Kabili – Macquarie Research Equities

Good morning, thanks guys. I wanted to circle back on tax and you mentioned there was an item in the third quarter related to a European event, if you could help us with how much that was and what you kind of see the sustainable tax rate going forward and into 2010?

Albert P. L. Stroucken

The European event was we took our operations in Spain, which we’re operating on a country level and we have moved the operational headquarters into Switzerland. So you have a settlement with the Spanish on the tax line, called an exit charge, when you move your headquarters. And so that is one time charge that gets you in that quarter. And then, the other thing that’s happening is Venezuela will be putting some pressure on our tax rate as well, which is why we moved our guidance from that 24% to 25%, 26% to 27%. And probably too early to really talk about 2012 except – excuse me, 2010 but I’d say that probably this year, next year, ought to look pretty much the same but we really aren't far enough along to give any clarity.

Albert Kabili – Macquarie Research Equities

Okay. And then I also – a follow-up, wanted to discuss the restructuring items in Latin America and what the expected cost savings are from those that could roll into next year, one? And then number two, I am still a little bit confused on the closer of the furnaces there, just given that, that’s a growing market. Are you keeping net capacity the same as you are closing those furnaces? Helps us with that a little about a little bit?

Albert P. L. Stroucken

Well. In fact, we had those discussions last week with our Latin American team and in fact we are increasing our capacity to the steps that we were taking because we are moving equipment to the markets that has a greatest need at this point in time. And at the same time, are pulling furnaces much more efficiently.

Albert Kabili – Macquarie Research Equities

Okay. And then that savings?

Albert P. L. Stroucken

Well the savings are really tracking with that, what we call kind of that two-year payback, two to one, that - and I wanted to go back a little bit on the machines as well. Our machines will range from 16 cavities would be an eight double machine, usually up to 30 cavities. So by putting all the big machines under the same big furnaces we’re actually going to get more glass out of our furnaces, which mean you don’t need some of the smaller, high cost furnaces. So, it's really going to be some nice cost savings there but expensive to move machine lines around and do a lot of conveying and things like that. So that’s why we want to call out that number and net it in our footprint for the fourth quarter.

Albert Kabili – Macquarie Research Equities

Okay. Thank you.

Operator

And you next question is from the line of Claudia Hueston with JP Morgan.

Claudia Shank Hueston – JPMorgan

Hi, thanks very much. Good morning.

Edward C. White

Hi Claudia.

Albert P. L. Stroucken

Hi Claudia.

Claudia Shank Hueston – JPMorgan

I just had - I know it’s a bit early but I wondered Ed, if you had any thoughts on pension for 2010 just yet?

Edward C. White

All I can say is, with the smoothing in FAS-87, that what it is - our pension expense will be higher next year then it is this year. From our cash side we don’t see any, any change in our cash contributions. But the real numbers, it all depends on asset values on December 31st, so I will just stay tuned.

Claudia Shank Hueston – JPMorgan

Okay. And then I was hoping could you just talk a little bit about your priorities for cash and how you are thinking about that going forward? Thanks.

Albert P. L. Stroucken

Well, Claudia, Ed can add to this. As we are looking at our company and we’ve gone through the steps with the footprint alignment over the last couple of years. It’s quite obvious that we also have set the stage for an expansion of our business and for growing our business in the future. And that is going to require most probably, for us to continue to invest in our operations. We will put more emphasis on reducing the typical maintenance capital needs that we’ve had in the past even further because we want to put more emphasis on putting capital into our operations that give us a very high payback. And the guidelines that we have set internally are a payback of between to 2 to 2.3 years or so as minimum for those capital requirements. And what we are seeing is we are getting quite a wish list of projects and opportunities that are available to us and presently sorting through that. But I would say it would be safe to say that we are seeing some good opportunities for our application of capital in the next two or three years to make sure that some of the benefits that we are seeing and some of the insights that we have gotten through our footprint initiatives can be multiplied and can be applied to the remaining and existing infrastructure. In addition to some expansion projects that we see for the markets that we have, I think, identified before, which were Latin America in particular our Australia and New Zealand, which have always been pretty solid growth markets for us.

Edward C. White

Al has given you the strategic view. I’ll give you kind of tactical for the quarter as we look at our cash balances we are going to have the heavy capital spending the first quarter of next year due to the seasonality of our business is always uses cash. We also have some term in Australia that’s our highest debt that we could really repay. There is also looking at some - do we refund some more into our pension plans, which would also be accretive with its implied returns there? So, there is some tactical things we will be doing but the big picture is what Al gave you, really it’s our core priorities that we can execute against.

Claudia Shank Hueston – JPMorgan

Okay thank you very much, I appreciate that.

Operator

And your next question is from the line of Alton Stump with Longbow Research.

Alton Stump – Longbow Research

Thank you. Good morning.

Albert P. L. Stroucken

Good morning Alton.

Alton Stump – Longbow Research

As you look ahead to the course of ‘10 I think you mentioned that – or I think it was you, Al, that you expect to see some growth come back on the volume front in the first half of the year. And I was just curious if you could maybe break that down or at least give us a bit of color as to whether or not you think there could be further market share losses as you do stay from on pricing next year or you think you will grow in line with the industry.

Albert P. L. Stroucken

Alton, I think again I cannot really say specifically what’s going to happen in one or the other quarter, but I’d say overall from a strategy, what we have seen is that most probably the biggest shock to the system and thereby the possibility of losing volume, is really behind us. That was when we had to go the repair phase of the margins, which really it was the biggest area of contention in some of our customer relations. But I think we worked our way through that. I think we have seen some of that impact already in the course of this year and we might see a little bit more, but I don’t think it’s very significant on a global scale. And we are now in the phase where we are going to create a more cooperative relationship again, or build that cooperative relationship again by new product introductions by technology advancements that we were working on with our competitors. So I think, the phase of contention, when we needed to really fundamentally change our margins is largely behind us, so I feel fairly confident that our forward momentum will be quite positive in the relationship with our customers.

Alton Stump – Longbow Research

Okay, thanks, that’s all I had.

Operator

And your next question is from the line of Richard Skidmore from Goldman Sachs.

Richard Skidmore – Goldman Sachs

Good morning. Al, you mentioned with regards to your contract negotiations in North America that you still had something is going on there. You mentioned the margin goal. Can you just remind us what your margin goal is in North America?

Albert P. L. Stroucken

Well, we have not specified that by individual region. But we have said, in the past that we want to get with our EBIT margins in the range of 15% to 17%. And I think we are getting close to that number as you already saw in the third quarter. So I think that too, is indicative of our ability to get to that point. You will see, in North America margins improved significantly from last year to this year. Now, I have to admit, part of that is, of course because of the mechanisms that we still had in the old contract because we had high inflation in 2008, coming into a relatively milder inflation period 2009 our margins expanded. The renegotiated contracts however are starting from that base and so therefore we are seeing a much more permanent impact on this margin improvement then also the provision that we can pass through now, more volatile cost items very frequently in the course of a year. I think is going to allow us for North America to be reasonably reflective of what we are able to achieve on a global scale.

Richard Skidmore – Goldman Sachs

And on those contracts that you have that you are currently negotiating have you closed on any of them yet? Are they still all open or what percentage is still left to close?

Albert P. L. Stroucken

Well, I’d say that the heavy lifting is behind us. We were in the phase of basically coming to contract language that is acceptable to both parties.

Richard Skidmore – Goldman Sachs

Thank you.

Operator

And your next quarter is from the line of Joe Stivaletti from Goldman Sachs.

Joseph Stivaletti – Goldman Sachs

Yeah, I was just wondering from a bigger picture perspective if you have anything on the acquisition front, any thing that is high on your priority list, given your hefty cash balance?

Albert P. L. Stroucken

Well Joe, as we have said in the past, focus areas for us are Mexico, Argentina, Brazil, Chile, China and some other geographic regions of the world where we feel there is permanent growth and where glass has a very high market share and very strong market position. As you can very well imagine with this economic downturn, many more projects are suddenly on the table than they were before. However, there still is a disconnect between what people think these businesses should sell for and what we think we are willing to pay for those. I think it will still require some time until people are no longer demanding a value that is tied to their peak years but a value that’s more reflective of the actual performance of the business at this point in time. But we are certainly seeing increased number of opportunities and we are going to be very careful to make sure that they are clearly aligned with our geographic strategies that we have outlined, and that they make sense for the corporation to position ourselves long-term in such a way that we can remain the number one supplier of glass containers in the world.

Joseph Stivaletti – Goldman Sachs

Great, thank you.

Operator

And your next question is from the line of Chip Dillon with Credit Suisse

Chip Dillon – Credit Suisse

Hi, good morning.

Albert P. L. Stroucken

Good morning.

Chip Dillon – Credit Suisse

Just two questions, one is I know this is only maybe [20] or so percent of your business outlook. Could you talk a little bit more about Asia, you’ve historically had very good margins there and then you hit sort of a wall earlier this year. And now the third quarter seems to be coming back. Should we expect sort of a mid to upper teens EBIT level going forward, is that going to continue to be normal there? And then, if you could give us any read on what you might do in terms of, an asbestos charge this year?

Albert P. L. Stroucken

Hey, let me talk about the Asia Pacific question that you had. I think we got a lot of questions in the last quarter about Asia Pacific because it had such a dramatic drop in margin. And what we tried to convey and explain is that we had basically two furnace rebuilds occurring in the Asia Pacific region during the quarter, which required us also to ship product, quite some extensive distances, to still serve our customers. And so, we had to absorb those freight costs on top of the fact that we were not producing in those facilities. And that really combines with an inventory correction that we went through at the same time because the second quarter of this year is, of course their winter. So that was the time when we had to cut back on inventories, which really affected the margins dramatically. Now, what you’re seeing really in the third quarter is a return to normalcy for the region. I would say longer-term, when we are expanding our business a bit more in China those margins might see some pressure, because in China the margins tend to be a little bit lower than we would typically see in the rest of Asia Pacific. But I think that’s going to be way out at this point in time. With regard to asbestos, perhaps Ed can make a comment or two.

Edward C. White

Yes, Chip, as you know, we do kind of a deep dive on our asbestos liability in the fourth quarter. We always look out several years, we thing going beyond that you’re really - no one has ever been able to figure out asbestos more than several years out. Last year, we took a charge of 250. We haven’t really started our analysis yet, but you certainly have seen the trends where filings are down this year, pendings are down this year. Our cash spending is running about 12% lower than it was last year. So we would expect that charge to certainly be lower than it was last year.

Chip Dillon – Credit Suisse

Got you. Thank you.

John Haudrich

Angela, we have time for one more question.

Operator

And our final question comes from the line of Peter Ruschmeier with Barclays Capital.

Peter Ruschmeier – Barclays Capital

Good morning.

Albert P. L. Stroucken

Good morning Peter.

Peter Ruschmeier – Barclays Capital

A couple of questions, I was curious Al, if you could help us to better understand the 18 furnace right sizings with your footprint since you started the program? How much of your productive capacity does that cumulatively represent? And how much of that is offset by improved productivity and throughput so I'm really looking for what kind of net capacity change you think you've seen for the company?

Albert P. L. Stroucken

In big numbers or in grand terms, let me say we have I think always said we have about 180 furnaces as installed so 18 furnaces about 10% of that nominal capacity. However, you have to keep in mind and what we've said with regard to the Latin American activities not all of those furnaces really mean a full complete shutdown of that capacity because we have taken machines and we have taken customers that were serviced by those furnaces to other locations and to other plans and you will recall perhaps that was a big issue for instance in the closure of our facilities. In Canada where we moved a lot of that production into facilities in Brampton and in Montreal and that really has helped us significantly. So just by taking out the installed capacity does not necessarily mean a like-for-like reduction in actual available capacity for us.

Now the other thing that you have to keep in mind as well is, we’ve gone through a very long period of acquisitions. And we've always said we look at acquisitions as part of the consolidation process. I think some of things that you are seeing happening at this point in time is that consolidation by itself is not only a glomeration of manufacturing facilities and capabilities. It's eventually getting the efficiencies out of those manufacturing facilities and I think what you are seeing happening in our company at this point in time is really the true benefit of the consolidation, which is taking our footprint that can be easily served from other installed capabilities that we have.

Peter Ruschmeier – Barclays Capital

Is it possible to suggest a range or percentage, if you keep half of the capacity through productivity initiatives or is it 70%?

Albert P. L. Stroucken

Well we had a typical productivity improvement pattern over the last five or six years or even longer of about 1%, 1.5% to 2%. So you can easily imagine with the large installed capacity that we have. If we for three or four years or five years have this productivity improvement and only an underlying market growth of 1% or 1.5% we're automatically creating always additional capacity that eventually then we have to correct.

Peter Ruschmeier – Barclays Capital

Okay that’s very helpful…

Edward C. White

We've also in the same period of time built three new furnaces, two in Peru and one is half completed in New Zealand.

Peter Ruschmeier – Barclays Capital

Okay, very good. Al, you mentioned that you expect a significant benefit from a renewed contracts I know you are still on discussions but is it possible that help us to somehow quantify or better understand even a range of expectations of what a significant benefit might mean for North America?

Albert P. L. Stroucken

I would feel more comfortable talking with you about that in the first quarter after we have signed, sealed and delivered the agreements because I think, I want to make sure that we got full agreements with our customers before I start with talking about it.

Peter Ruschmeier – Barclays Capital

Very good, congratulations for the strong result.

Albert P. L. Stroucken

Thank you.

Edward C. White

Thank you.

John Haudrich

That concludes our third quarter earnings conference call. We appreciate your interest in O-I. Please note that our fourth quarter conference call is scheduled for Thursday, January 28, 2010 at 8.30 a.m. Eastern time. Thank you and have a good day.

Operator

Thus does conclude today’s conference. You may now disconnect.

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Source: Owen-Illinois, Inc. Q3 2009 Earnings Call Transcript
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