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Owens-Illinois (NYSE:OI)

Q4 2010 Earnings Call

January 27, 2011 8:30 am ET

Executives

Albert Stroucken - Executive Chairman, Chief Executive Officer, President and Member of Risk Management Committee

John Haudrich - Vice President of Investor Relations

Edward White - Chief Financial Officer and Senior Vice President

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 O-I Fourth Quarter and Full Year 2010 Earnings Conference Call. [Operator Instructions] Thank you. I would now like to turn the call over to Mr. John Haudrich, Vice President of Finance. You may go ahead, sir.

John Haudrich

Thank you, Angela. Good morning, and welcome, everyone, to O-I's full year and fourth quarter 2010 earnings conference call. I'm joined today by Al Stroucken, our Chairman and CEO; Ed White, our Chief Financial Officer; and several other members of our senior management team.

Today, we will discuss key business developments, review our financial results for the fourth quarter as well as the full year and discuss future trends affecting our business in 2011. Following our prepared remarks, we'll host a question-and-answer session. Presentation materials for this earnings call are also being simulcast on the company's website at o-i.com. Please review the Safe Harbor comments and disclosure of our use of non-GAAP financial measures included in those materials. Unless otherwise noted, 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. Note that our financial reporting now treats our Venezuela business as a discontinued operation. Therefore, our current and prior-period financial results exclude Venezuela. More details are included in the appendix.

I will now turn the call over to Al, who will start on Chart 2.

Albert Stroucken

Thank you, John, and good morning. 2010 was a year of transition for O-I as we completed our multiyear program to repair margins and shifted our focus to expansion in fast-growing emerging market. You can see the impact of this strategic shift in our financial results.

Segment operating profit increased more than 8% from the prior year. This increase reflected both our margin repair efforts as we completed our 2010 North American restructuring program as well as emerging market growth, particularly in South America. Higher operating profit was offset by additional non-operating costs, including pension and interest expense. As a result, O-I reported full-year 2010 adjusted net income of $2.60 per share compared to $2.61 in 2009.

Volumes improved in most of the markets that we served in 2010, especially South America. Shipments also increased across nearly all end-use categories including wine, spirits and food. Here in the mature markets was the notable exception as consumption was down primarily due to continued high unemployment. In total, shipments from continuing operations were down about 1%. Our shipment trends reflect additional volume from acquisitions and volume loss tied to customer contract renegotiations that supported our margin restoration efforts. Excluding these factors, our underlying shipments were up 2% from 2009, which was in line with gradually improving consumption trend. Globally, lower manufacturing and delivery costs reflected the improved operating rate and footprint savings from restructuring activities, which more than offset cost inflation.

The expropriation of our two plants in Venezuela was an unexpected and unfortunate development. However, we are optimistic about the future contributions of our 10 newly acquired plants and the three new furnaces we built this year to serve fast-growing markets in South America and Asia.

Most of the developments I discussed regarding full year 2010 also apply to the fourth quarter. Fourth quarter 2010 adjusted earnings were $0.45 per share compared to $0.43 in 2009. Segment operating profit increased more than 25% over fourth quarter 2009. This improvement was mostly due to higher capacity utilization as the inventory correction we conducted in late 2009 did not repeat, given our positive growth outlook for this year.

Overall, our average fourth quarter selling price was consistent with prior year. Globally, our total shipments were flat with the fourth quarter 2009, while underlying shipments were up 2%, similar to our full year trends.

In the fourth quarter, we completed the acquisition of three plants in China, including one in Guangdong and two near Beijing. We also opened a newly constructed furnace in Auckland, New Zealand.

Looking to 2011, we expect higher shipment and production level. This reflects strong growth and expansion in emerging market. Sales will benefit from organic growth as markets continue to recover. We are also investing in our own sales and marketing innovation capabilities. Part of the strong growth we experienced in our South American region this past year was attributable to a new robust sales and marketing program. We are now implementing this leading practice across all regions in 2011. Further, higher selling prices will partially offset additional cost inflation.

Free cash flow should improve significantly in 2011. We expect lower restructuring charges and capital expenditures now that we have completed our recent footprint initiatives and invested in new capacity during 2010 for future growth. Overall, 2011 free cash flow should approximate $300 million. Expansion in the high-growth markets will remain our top use of free cash flow.

Now let's review our operating performance on Chart 3. Here, we show segment operating profit and margins for the company, as well as for each of our four regions. Full year profits are on the left and fourth quarter results are on the right. Our full year 2010 segment operating profit was $964 million, up $73 million from last year. Margins improved to 14.6% from around 13.5% in 2009. Favorable foreign currency translation represented $60 million of the year-over-year profit improvement. Most currencies strengthened against the dollar, which helped offset the impact of a weaker euro. Segment operating profit was comparable with the prior year for most regions, with the exception of South America, which posted a significant improvement from 2009.

In Europe, segment profit was $324 million, a decline of $9 million from the prior year, but profits actually increased approximately $10 million in the currency neutral basis. While we did experience some pricing pressure, volumes were up low single digits and operating rates improved. Our North American operating profit of $275 million was just below prior-year results, which is a significant achievement given all the restructuring activity during 2010.

The benefits from higher selling prices and footprint savings offset a 12% volume decline following customer contract renegotiations. Adjusted for these contracts, North American shipments were down slightly from 2009, reflecting a sluggish U.S. beer market.

Our South American segment profit was $224 million, up 55% from 2009, reflecting very strong growth in our business. Shipments improved more than 30% from last year. Most of this increase reflected the rebound in consumption and new product introductions. The balance of the improvement was attributable to new business from acquisitions, additional furnaces and footprint optimization efforts.

Asia-Pacific's operating profit of $141 million increased $10 million on the prior year, added by favorable currency translation. Volume trends in the region varied by country. Shipments were down in Australia and New Zealand, as strong currencies in those countries impacted wine exports. And beer consumption was also down in Australia.

In China, on the other hand, our shipments were boosted by increased consumer demand. To support this growth, we expanded our base in China through several acquisitions, and we also entered into a joint venture in Southeast Asia.

Turning to the fourth quarter. Total operating profit was $221 million, up from $174 million last year, reflecting a strong performance in both North and South America. The impact of currency translation was negligible. Our European operating profit was $50 million, up $10 million from the fourth quarter of 2009.

Average selling prices declined modestly. However, shipment levels improved by low single digits from the prior year, and higher productivity led to lower manufacturing costs. Market conditions continue to vary, but we did see some improvement over the course of the quarter. While beer remained weak, the end-use categories like wine and food showed solid growth.

In North America, operating profit was $53 million, an improvement from $33 million in the fourth quarter of 2009. Shipments were down about 10% from the prior year, reflecting the customer contract negotiations that I mentioned earlier. Excluding the impact of those contracts, North American shipments were flat with the prior year. Earnings benefited from improved selling prices, as well as higher productivity now that our current restructuring program is complete.

Our South American operating profit was $82 million, a 70% improvement from the prior year, representing the best performance across our regions. Total shipments were up nearly 50%. Organic growth represented more than half of the increase as a broad-based economic recovery benefited all end-use segments. Our recent acquisitions and new furnaces, which are performing very well, made up the balance of our higher shipments this quarter.

Our Asia-Pacific operating profit was $36 million, a decline of $17 million, as total shipments were down more than 10% from the prior year. This decline reflected challenging market conditions in Australia and New Zealand. Strong currencies in those countries impacted wine exports, higher interest rates, and unfavorable weather conditions in Australia resulted in lower consumer spending, which impacted our customers' sale. In fact, domestic beer consumption was down 10% from the prior year, according to recent retail statistics.

Volume growth in China was capacity-constrained. To enable future growth, as I mentioned, we acquired three plants in China near year end. We see many opportunities to better serve this expanding market as we drive productivity improvement in these locations. Overall, we faced different challenges and opportunities in 2010, and our segment operating profit improved in both the full year and fourth quarter of 2010.

Going to Chart 4, more importantly, we really expect our operating results to improve further during 2011 as markets continue to recover and our recent acquisitions drive additional profitable growth. As illustrated on Chart 4, we made progress this past year as we completed four acquisitions, one joint venture and constructed three new furnaces. As a result, we have added 10 new plants and 24 new furnaces to our manufacturing footprint in high-growth markets including Brazil, Argentina, Peru, China, Vietnam and Malaysia. O-I is now the largest glass container producer in Brazil and the second larger producer in China, two very important markets for O-I as they both have excellent long-term growth opportunities.

Our strategy is focused on bolt-on acquisitions, and integration efforts are off to a good start. Overall, we are seeing very promising productivity improvements at these facilities. In total, we expect our expansion investment will be accretive to 2011 earnings and will improve further in future years.

We have been reorienting our business to the growing, emerging markets. As illustrated on the right, we have added a significant number of furnaces in South America, as well as China and Southeast Asia. Now more than 25% of our capacity is in these fast-growing markets. Over time, we will continue to increase our commitment to these emerging markets, and we'll significantly improve the growth profile for O-I.

I will now turn the call over to Ed.

Edward White

Thanks, Al. Let's begin our financial review with the fourth quarter reconciliations for sales, operating profit and EPS on Chart 5. Please note that these reconciliations reflect continuing operations only. 2009 amounts have been restated to exclude the impact of our Venezuelan business. The appendix includes more details on this reclassification, as well as our full year 2010 reconciliations.

Fourth quarter 2010 segment sales decreased slightly to $1.7 billion. As expected, price and product mix were essentially flat with the prior year. And, as we have seen all year, cost pass-through provisions in our North American customer contracts resulted in a small impact on sales and had a negligible effect on operating profit.

Moving to sales volume on the following line, glass shipments, in tons, were flat with the prior year on a global basis. Its sales dollars increased by $17 million, reflecting favorable regional sales mix, especially from our acquisitions in South America. Finally, currency translation reduced our top line by $29 million in the fourth quarter. This impact was due to a weaker euro, partially offset by stronger currencies in other countries.

Moving over to segment operating profit, the fourth quarter was $221 million, up $47 million from the same period in 2009. Since price and product mix were essentially flat, they had very little impact on operating profit. While volumes were also flat, operating profit benefited by $7 million from improved regional mix, given the strong growth of higher margin business in South America. Manufacturing and delivery costs decreased $35 million, due to the benefits from footprint savings and higher operating rate. However, this was partially offset by $20 million of cost inflation, mostly driven by higher energy prices.

Finishing with the EPS reconciliation, our adjusted net income was $0.45 per share in the quarter, compared to $0.43 in the prior year. Operating profit was up $0.21 from the prior year. However, earnings were impacted $0.19 from unfavorable non-operating items. These included additional non-cash pension expense, which drove higher corporate cost. We incurred $0.08 of additional interest expense on incremental debt to fund our several accretive acquisitions. Finally, the effective tax rate was higher than last year, reflecting our current regional earnings mix.

I have two comments on GAAP EPS. We reported approximately $160 million of Note 1 charges in the fourth quarter, primarily related to our annual asbestos review and reserve adjustment. And, as we discussed in our 8-K filing last month, we incurred a onetime charge of $329 million in the fourth quarter, to write off our Venezuelan net assets and the related cumulative currency translation adjustments recorded in prior years. The company continues to negotiate with the Venezuelan government with respect to certain aspects of the expropriation, including compensation.

Let's move to Chart 6 for more detail on our balance sheet and on asbestos. Keep in mind, this information reflects Venezuela classified as a discontinued operation for both 2009 and 2010. On December 31, cash was $640 million and total debt was $4.3 billion. Net debt was $3.6 billion, an increase of $785 million from 2009 as we put our healthy balance sheet to work to fund several acquisitions. Our net debt to EBITDA ratio was around 2.8x at year-end 2010 and remained within our target leverage range of between 2x and 3x EBITDA. Our underfunded pension liability was $530 million at year-end, compared to $540 million in the prior year. We generated free cash flow from continuing operations of $100 million in 2010, and this was after prefunding approximately $35 million of 2011 tax payments and pension contributions in late December.

As Al mentioned, 2010 was a year of transition. Capital expenditures peaked as we completed our restructuring activities and, at the same time, we invested in new furnace expansions to support growing markets. Working capital levels remained lean, as we did not need to repeat the significant inventory correction conducted in late 2009. And we are now positioned for more growth this year.

Turning to asbestos. Nothing has changed in the basic pack pattern. During the fourth quarter, we conducted the annual review of our asbestos-related liabilities. As a result, the company recorded a non-cash charge of $170 million in the fourth quarter. This charge compares to $180 million in 2009. Likewise, asbestos payments dropped by $11 million from the prior year.

As illustrated in the chart, about 3,200 new cases were filed in 2010, compared to 6,000 in 2009. The number of total pending cases at the end of 2010 was 5,900, which is 1,000 fewer pendings than the prior year. Overall, asbestos remained a limited and declining liability.

On Chart 7, we present our business outlook for both first quarter and full year 2011. We have provided the usual directional guidance and expanded disclosure for annual price, volume and cost trends, as well as a number of cash flow items. Of course, as with any estimates, they are subject to change throughout the year. Overall, we're looking forward to a good year as we profitably grow our business and significantly improve free cash flow generation.

Let's review the first quarter trends. As you can see, we expect improved pricing, higher sales volume and lower manufacturing cost. These will more than offset additional cost inflation. But we do expect higher non-operating cost, which I will review further in a minute. In addition, I'd like to highlight a couple of first quarter events.

Sales volumes should be up across all of our regions, including Asia-Pacific. Unfortunately, flooding in Australia this month has affected our customers and our Brisbane plant, which was shut down for several weeks in January. As a result of the flooding and continued challenging market conditions, our first quarter Asia-Pacific segment operating profit could be down modestly from prior-year levels. We greatly appreciate the efforts of our Australian team, which has been working night and day to serve our customers and get the Brisbane plant back into production.

Next, we deferred furnace maintenance in South America during the latter half of 2010, as very strong growth required high operating rate. Now taking advantage of a seasonally slower period, we will be conducting a number of furnace rebuilds across that region during the next 90 days. While total first quarter operating profit in South America will improve modestly from 2009, profit margins will temporarily dip below the prior year. These discrete items had impacted the first quarter; however, we expect the rate of our financial improvement to accelerate starting in the second quarter. We continue to see gradually improving market conditions and are encouraged about the contributions from our numerous recent acquisitions. In fact, our January month-to-date volumes are positive in every region and total shipments are up mid to high single digits over prior year.

Let's review our key business factors for full year 2011. Price and mix. Following slight cost inflation in 2010, we expect modestly higher selling prices this year, which should positively impact global sales by up to 1% in 2011. Broadly speaking, prices should improve across all regions.

Sales volume. We expect global shipments will increase between 5% and 10% from 2010 levels. Recent acquisitions should boost volume between 3% and 5%, most notable in the first half of the year. Further, we anticipate organic sales growth will range between 2% and 5%, lead by innovation and overall economic improvement in each region. Please note in North America and Europe, organic growth would yield EBIT contribution margins of between 40% and 60%, depending on the plant. This is higher than normal due to the significant operating leverage to improving volumes that remained in those regions. Contribution margins in emerging markets, from both organic and acquisition-related growth, would be closer to the historic averages for those respective countries given their high operating rates. Keep in mind that during the first quarter, we will anniversary the contract changes that resulted in lower beer shipments in 2010, so future volume trends should compare more favorably to prior-year levels. And, over the course of the year, volume trends should also improve on a year-over-year basis.

Cost inflation. While 2010 cost inflation totaled only $20 million, we anticipate 2011 inflation will range between $150 million and $180 million, or about 3% of cost of goods sold. Most of the increase is due to higher raw material prices including soda ash, as well as generally higher energy and labor cost. Currently, we estimate that price improvement in 2011 would partially offset this conditional cost inflation forecast. Having said that, we will continue to seek opportunities over the course of the year to better offset cost pressures with additional higher selling prices.

Other manufacturing and delivery costs. As shipment levels in North America and Europe increase, our operating rates should improve, resulting in lower unabsorbed fixed cost. And we expect productivity and logistic initiative will provide additional benefit. Further, the completion of our footprint efforts in North America will generate $30 million to $35 million of incremental savings across the first half of 2011.

Other costs. We anticipate approximately $70 million to $80 million of additional operating expense and corporate cost, including $20 million of higher non-cash pension expense. As Al mentioned, we expect to further enhance our sales, marketing and innovation capabilities to drive top line growth. This includes our global sales and marketing program and an SAP information system for the Americas. We see these investments as a meaningful way for O-I to advance its strategic priority to strengthen glass marketing.

Overall, the rate of spending will be managed throughout the year, depending on our financial performance. Interest expense is expected to increase $35 million in 2011, as we used our balance sheet to finance our recent acquisitions. As we mentioned, our acquisitions will be accretive this year, so improved operating profit from these transactions will more than offset the financing cost. Our 2011 effective tax rate should approximate 27%. Tax expense and tax payments should be about the same.

Free cash flow. Our major restructuring program is now complete, and we're well positioned for growth in the emerging markets. As a result, CapEx should decline from $500 million in 2010 to approximately $350 million in 2011. Restructuring payments would drop from $61 million in the prior year to approximately $20 million in 2011. Expected pension contribution and asbestos payments are also provided on Chart 7. While we target further working capital efficiency, working capital will most likely be a modest use of cash in 2011 as sales increase. Overall, free cash flow should approximate $300 million this year.

In summary, we expect both improved financial results and greater free cash flow generation in 2011. Now, I'll turn it back to Al on Chart 8.

Albert Stroucken

Thanks, Ed. As mentioned several times before, 2010 was a year of transition for O-I, and we are confident that our external and internal investments will benefit earnings in 2011. We have secured our foundation by successfully concluding our three-year program to repair our margins and realign our footprint. Now we have shifted our focus to profitable growth.

In 2011, we will continue to expand our business in attractive emerging markets, including acquisitions. We will further develop our sales and marketing capabilities to profitably grow our business and create innovative packaging solutions for our customers and more differentiation for O-I in the marketplace. And, of course, we will continue to drive further operational excellence and apply our know-how to reduce costs. We expect a stronger financial performance in 2011 as a result of these initiatives, and this includes significantly higher free cash flow in 2011 and beyond.

Now, I will ask Angela to open the lines for your questions. Thank you.

Operator

[Operator Instructions] And your first question is from the line of Richard Skidmore with Goldman Sachs.

Richard Skidmore

Al, can you just talk about, on the slide where you have your 2011 outlook, the reconciliation of price versus the cost inflation? I understand over the last couple of years, '07, '08, '09, you went through a major price initiative, and then I believe that the conversations in '10 with the price would offset inflation; and yet in 2011, it looks like you'll be behind in that? Can you just help us understand that a little bit better about how your contracts are working? And would you go back into a situation that you were in, in '05 and '06, where you kind of lagged inflation from a price standpoint?

Albert Stroucken

Yes, Rick, let me try to give you some perspective on that. Number one, first of all, our inflation is a projection, and it's really influenced significantly by what could happen in the last few months, with regards to commodity prices and with regards to energy prices. We have put a significant focus in the long-term contracts on making sure that we have quarterly pass-through provisions for energy. But still, if you have an escalating energy price development, you still run behind one quarter in each of the successive quarters. Now it may very well be that in the course of the year, there are going to be ups and downs from one quarter to the next. Then, of course, this profile would change a little bit, and we would not have this factor that we would be running behind. With regard to the more stable prices that we have seen in the past, with regard to commodities, in particular, that affects our raw materials, we generally have annual pass-through provisions. And as we have gone into this year, of course, the evolution that we saw last year was pretty mild, so the price adjustment has been fairly low. Now as we go through this escalation of commodity prices in this coming year, we will be running a bit behind, but I think overall, of course, that would fix itself again and in the subsequent year. And I believe that the dynamics that we're seeing are predominantly related, of course, to the longer-term contracts. And now you know that in Europe, which, of course, is a significant share of our business, we only do about 30% of our volume in longer-term contracts. So the contracts in Europe are more determined on a short-term annual basis. And of course, it's very difficult at the beginning of the year, as you negotiate these contracts, to argue that at the end of the year, raw materials are going to be much higher and, therefore, the price should be much higher. So I think what we'll see in the course of the year is, hopefully, our competitors in Europe will also see these cost increases coming in, and that will hopefully allow us to do some additional price adjustments. So we'll keep an eye on it, and we'll keep moving to make sure that we get recovery as quickly as we can. But coming into this year, with especially the escalations happening so rapidly in the last three months, it's very difficult to really fully include that in our model, so we tended to be a bit more careful.

Richard Skidmore

How many of your contracts actually have that quarterly pass-through on energy? Is it across the whole footprint or something different?

Albert Stroucken

In North America, yes, in Europe, as well, for the longer-term agreements. I think there may be one or two exceptions in Asia-Pacific, but that's about it.

Operator

And your next question is from the line of Chris Manuel with KeyBanc.

Christopher Manuel

I wanted to follow-up on Rick's question, just so I fully understand this. When I look at the year-over-year inflation, in North America, you're largely on quarterly mechanisms. Europe, I think you said 30%. Your other business is largely negotiated annually, so you'd be able to offset that. So as I look at that $150 million the $180 million that you've got as a rough estimate, would it be safe to assume, as we look at that, that your mechanisms in normal pricing would offset at least 75% of that or three quarters out of the one quarter you'd be behind of the year? Is that an appropriate way to kind of think about that?

Albert Stroucken

Chris, it depends a little bit from what segment of your cost structure the cost increase has come. And as I said, in the energy area, we have pass-through provisions. And at this point in time, of course, it depends on how quickly will energy move in the course of the year, because there still is going to be a quarterly lag, and that quarterly lag, if it is a continuous increase throughout the year, you have four quarterly lags that you're not recovering. And they, of course, over the course of the year, add up. The other part is with regard to basic raw materials like our soda ash and other products, those tend to have faster provisions on an annual basis. And there is, of course, when you have a dramatic change or a rapid change in the course of the year, you have to wait until the following year. The third part that I believe is important to consider is that we are also projecting a cost evolution in the course of the year. Now at the beginning of the year as we set our annual contracts, of course, it was very difficult to argue for higher prices in November, December or September, October, November, December that you expect as there is no proof that you can demonstrate to your customers. And, of course, that also depends a little bit on how proactive your competitor stands to be in passing through those prospective increases in cost.

Christopher Manuel

The second part is you indicated that sales and marketing expense would be up year-over-year, and you did that in South America last year. And as we look at the results, it seems to have bore out [ph] out pretty well. What are the other big components in corporate expense that are going up so much? I recognize pension was 20%, but that's still 50% to 60%, that corporate expense, and component is up year-over-year. Can you maybe give a little more color there?

Albert Stroucken

Yes, we also have an SAP implementation that's taking place in the Americas. And as you know from past experience and from other companies, SAP implementations tend to be pretty expensive.

Operator

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

Ghansham Panjabi

On the EPS wait in between the first half and second half, you gave us some general thoughts on the first quarter, but is a 40-60 split between the first half and second half sound reasonable, just based on what you said?

Albert Stroucken

40% of the EPS would be first half and 60%, second half?

Ghansham Panjabi

Yes.

Edward White

I think there's not enough data to call that, Ghansham.

Albert Stroucken

I think, Gansham, the difficulty, really, is that the pattern that, perhaps, we have seen in the past may not be reflective of the patterns that we're going to see in the future, especially if we have an economic recovery. If you have an economic recovery and it tends to start in the first part of the year, then perhaps that overall percentage may be skewed a little bit to the second half.

Edward White

We don't want to put percents around that, but I think what Al's giving you is certainly our directional feel.

Ghansham Panjabi

And now just a bigger-picture question, if I could. Lots of private equity activity in packaging over the past year. There is some speculation that [indiscernible]glass container business that you'll also be purchased by some of those entities. Your stock has been frustrating for shareholders, and I'm sure yourselves, over the last couple of years in the context of your franchise value and your ability to generate cash flow. Can you share some high-level thought there on how the board is thinking about all the different options to maximize shareholder value?

Albert Stroucken

I think it's quite clearly reflected in our strategy. What we're trying to do is to make sure that we are expanding regionally to the markets that are going to provide growth and momentum for the future. We are clearly putting quite a bit of effort in cost reductions and streamlining our operations as you have seen in the past couple of years. I also believe that if you look at what's happening in our surrounding arenas, with regard to transactions, that there still is ongoing consolidation, but that consolidation is shifting from Asia and from Europe and from North America to other markets. So I think the processes and the strategies that we're following at this point in time, certainly for a company that has been in the business for well over 100 years and hopes to be in the business for another 100 years, is most probably the best transition and the best strategy and the best way forward to maximize shareholder value.

Operator

And your next question is from George Staphos from Bank of America Merrill Lynch.

George Staphos

I wonder if you can get a little bit into the cash flow outlook for 2011. From our side, we're actually pleased to see the capital spending heading a bit lower. And Al, as we think about the line items that you delineated here, you mentioned that working capital might be of modest use. Are these basically the big runners, and so therefore, there will be no additional other source or uses of cash that you can envision right now in terms of free cash flow projection?

Albert Stroucken

I think we've tried to delineate what some of the factors are that are going to lead through this higher cash flow number. Now, as you know, this is a prediction. As the year evolves, we will see where some of those cash flow streams and needs are going to evolve. But based on our prediction at this point in time, of course, if we're going to grow in the range that we said, between 5% and 10%, it also will mean that we need to make sure that our infrastructure is in place to supply and to serve that additional requirement. And that's why we felt that working capital would have a modest consumption of cash flow going forward. I believe that we have, over the last couple of years, been under a significant influence, of course, of flat or even declining volumes in our company because of the steps that we have taken. I think if we are going to see a growth pattern evolve in the range of what we're predicting at this point in time, some of the dynamics in the course of the year may change as well, and we'll have to make sure that we adapt our approaches and our strategies appropriately at that point in time. But from all indications that we have and the forecast that we see at this point in time, the $300 million is an appropriate number.

George Staphos

Ed, would you say that more or less than all the other items would wash from a free cash flow standpoint?

Edward White

Well, what we try to do is, I'm going to say, we kind of bifurcate cash as you look at the business is going to generate more cash. And then you also, as we've mentioned, and I'll just emphasize, between working capital, higher interest and a higher tax rate and taxes, payments in tax expense are going to be about the same. Those three items are going to create more than $100 million headwind on the cash side.

Albert Stroucken

And of course, the additional OpEx that we talked about are going to detract from some of that cash generation that we expect in the course of the year.

George Staphos

When you say you're expecting improved 2011 results, without getting granular, does that include net income?

Albert Stroucken

Yes, certainly.

Operator

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

Albert Kabili

I wanted to just drill down a little bit on the cost inflation outlook on that $150 million to $180 million. How much of that is baked in as energy, where you have maybe a little less visibility on versus, I imagine, items like soda ash and labor, where much of that might be locked in or a lot of visibility for, I guess, the year?

Edward White

It's really a high level, globally. We see three buckets, and it's almost a third for each bucket between raw material inputs, energy and labor cost. And you're going to have, obviously -- we were feeling some inflation pressure on in our repair parts operating supply. But the major buckets are those three I just outlined. And because energy is a commodity and soda ash is a commodity, they really are the ones that are kind of driving the range. The labor cost, we kind of know pretty well what our contract negotiations, when they're going to end up.

Albert Kabili

And have you locked in most of your soda ash for the year? Or is that something that could be a variable versus your expectations as it fluctuates potentially in price throughout the year?

Albert Stroucken

It depends, again, regionally. I think the complexity of modeling O-I is such a global company. In China, for instance, it is the China soda ash price that's moving around, which, in some ways, has an impact, a little effect across the world. Yes, we have a lot of big chunks nailed down for 2011, but they're still on the margin piece of it.

Albert Kabili

Just given the visibility that you do have with labor going up and the visibility on the raw materials at current prices where they are at now, just given that visibility, I know you mentioned on the price side, it's hard to argue with customers, arguing about what items are going to be at the end of the year. But just given current inflationary run rates, it would suggest that you could have argued for higher pricing to get that cost inflation covered. Am I just missing something or can you help me with some of that?

Albert Stroucken

No, I don't think you're missing anything. I think, however, Al, what we got to look at, as well, we must balance many factors in setting our price. We must, of course, look at inflation and inflation expectations. We also have to look at competition. We have to look at the utilization rate of a factory, especially since we have, basically, downed the major price corrections. And all factors must be considered. And we must strike the right balance between price and volumes that maximize our operating profit. And I think the plan that we have at this point in time does that. If, of course, in the course of the year we see opportunity to do better than that, we will do so.

Operator

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

Timothy Thein

Price mix relative to cost inflation, are you getting or do you envision getting at price cost -- to be in a price cost-positive situation if you look by region? Do you expect that to be positive in South America?

Albert Stroucken

I think South America, typically, has a much more active and proactive scenario. And as you know, we don't have really a lot of long-term agreement and long-term contracts. And also, with the strong demand in Latin America, it's safe to assume that we'll be able to cover our inflation there.

Timothy Thein

So the biggest spread that I had presumed, is that coming in Asia-Pac and Europe then, where you expect to be -- where you see the biggest negative from?

Albert Stroucken

I think in the United States, as well. As I said, in the areas where we tend to have longer-term contracts -- and the longer-term contracts have pass-through provisions on a quarterly basis for the more volatile cost component like energy. But they only have annual pass-through provisions for the raw materials. You automatically can see where that difference is going to come from.

Timothy Thein

Switching gears quickly, on the volume comment, just so I'm clear on that, you mentioned the kind of 40% to 60% incremental leverage in terms of organic volumes in North America and Europe. Should we expect all the acquisition and kind of greenfield expansion is coming in, or most of it, in South America and Asia-Pac, we should anticipate an incremental margin in line with segment operating margins in those two regions? Is that what you're saying, closer to high teens or 20%, is that a right assessment?

Albert Stroucken

That's right, Tim.

Timothy Thein

So that would put you at a blended rate closer to the, call it, low 40s, if you look at what's been announced and what will flow in 2011, in terms of the incremental capacity. Is that a good blended average to use across the company?

Albert Stroucken

I'd say 30% to 40%. Why I feel that 30% out there, obviously, the growth in China, we've always been very public that our China margins are at the low end of the range. So that's why I'd be a little bit more conservative there.

Operator

Your next question is from Mark Wilde with Deutsche Bank.

Mark Wilde

Just a big picture, Al. When you were out here, I think, in the second quarter to present to us, you talked a lot about wanting to play more offense in the glass market, to be a little more proactive against other types of packaging. Are there any things that you can point to in terms of kind of tangible success so far?

Albert Stroucken

Yes, I think the activities that we were talking about that we're going to roll out in the rest of the world for Latin America with regards to the marketing activity are really moving in that direction. For instance, look at our evolution in Latin America. And even if you consider that Latin America's coming out of a recession, so some of the growth is also a recovery from a recession, it would still give us a double-digit growth in overall consumption and new businesses that we've picked up with these processes. In North America, of course, we have had some publicity with our Vortex innovation, and that also, of course, is giving some pretty good results and is going against, of course, alternative packaging, whether it's glass or whether it's other materials. I believe the real effort that we're going to engage in with these additional activities that we're pursuing is to really go after business that, in the past, already has been packaged in cans or has been packaged in plastic. And clearly, areas that are -- the greatest area for opportunity are food, as well as beverages, to really regain some of the positions that we may have lost in the past. But to do that effectively, of course, we have to have convincing projects and convincing models that we can work with, with our customers and jointly introduce this products into the marketplace.

Mark Wilde

Just as a follow-on, are there any lessons we should take from Venezuela?

Albert Stroucken

Well, of course, you can very well imagine that we've looked at this in fairly great detail. And you all know from the past that Venezuela has been a very attractive business and has really generated quite a high profit contribution to the company. And I would say, looking at all factors and clearly analyzing what was going on there, even in the hindsight, I think the risk-reward ratio was right for that region. Now unfortunately, of course, what happened is not very much to our liking. But I think that, still, we have to consider that basically every country in the world has the right to nationalize industries. The question really is can we really actively still be a global company and elect to not be present in certain markets. And I think having had a presence in Venezuela for more than 40 years, or 50 years, clearly, I think it has been a good decision. It has been a good investment. And I think that the only lesson that we learned from it is to make sure that in, perhaps, some of the other countries where there is some greater volatility, we at least have actions in place and plans in place to make sure that we can deal with a situation in a proactive fashion.

Operator

Your next question is from Chip Dillon with Crédit Suisse.

Chip Dillon

In the fourth quarter, you mentioned your shipments were flat year-to-year. And I was wondering what they would have been if you didn't include divestitures and acquisitions?

Albert Stroucken

I think we said that the underlying growth would have been 2%.

Chip Dillon

Well, actually, I think that was for the full year, maybe it's for both. I'm not sure. But I was just speaking just for the fourth quarter.

Albert Stroucken

It was 2%.

Chip Dillon

And then second thing, you mentioned that the only sort of -- well, not the only, but one of the biggest challenges is the beer market in the mature markets, namely North America and Europe. And Al, if we saw a big comeback, let's just say it was 4%, just to pick a number. In 2011, in those two markets, how much would that, do you think, impact the overall volumes? Could it be as much as 2%? Is it that big? Or maybe 1% to 2%?

Albert Stroucken

Well, I would say the entire market would become very tight very quickly. Not just our business, but I think the entire market would become very tight very quickly.

Chip Dillon

So you mean not only would there be volume business, but it might actually impact pricing as well?

Albert Stroucken

Well, I think, certainly, the supply-demand ratio might change, and that, of course, would have other factors well.

Chip Dillon

But again, on the sensitivity of it, if the beer market in those two regions did go up, again, to pick a number, I just want to know how much they are as a proportion of the overall company?

Albert Stroucken

Well, I think in our case, beer on a global basis is about half of our business. So if you have a 4% pickup in beer, that's about a considerable impact, of course, on our business. It's 2% on the overall sales.

Edward White

Chip, I would add Australia to that because if you'd looked at some of the big brewers down in Australia, their earnings calls, their consumption and consumer demands are down.

Operator

And our final question is from Peter Ruschmeier with Barclays.

Peter Ruschmeier

I was curious if you could share your preliminary observations about the opportunities you're finding in some of the acquired businesses, whether it be China, Brazil or Argentina. Has it been meeting your expectations, and what's your experience?

Albert Stroucken

I think we're very happy with the acquisitions and the improvements that we were able to make. In fact, in some of these, we have seen 10% to 15% productivity improvements in a very short period of time, which, of course, are very beneficial to the overall return that we're projecting for these businesses. But I think what is also happening, of course, is that it is giving us access to new geographies, like for instance, in Brazil, the northern part of Brazil, we were not really very active. And that really is a fairly strongly expanding market. The other part was in Argentina. We really never had a position in Argentina, and beer demand, as well as wine, in Argentina, are evolving very nicely. Similarly, Malaysia, Vietnam, I recently was there, and it's just amazing to see the vibrancy of the economy. So I think the strategy so far is working out very well. And, certainly, in the first six to three months, depending on when we did the acquisition of the transactions that we've done, we're very satisfied and very happy with the progress that we're making.

Peter Ruschmeier

Within emerging markets, largely a two-way market, however, there is an emerging one-way market. I'm curious, can you comment on what you're seeing in terms of the relative growth rates of the one-way market versus the two-way market? And how has your success been so far in China in terms of moving into more of the middle market?

Albert Stroucken

The strategy in China, clearly, was to make the acquisitions with those companies that had presence in the middle market because with what we had in place and where were located, it was very difficult to enter into that market. And so that strategy is working out very well. With regard to the mix between one-way and refillable, I think that's really an issue that's driven by the overall income levels in those countries. And even though we have strongly emerging middle-class sections in Latin America, as well as in Asia Pacific, the overall income level relative to, let's say, Europe or North America is, of course, still very low. So what we're seeing is continued use of refillable containers as the preferable packaging modality, because it does really allow our customers to hit that emerging middle class sooner in the curve because the packaging cost is so low on a per transaction cost that it really allows them to access a broader base of the market, but sooner. And that makes it a very attractive package in their marketing strategy there as well.

John Haudrich

Thank you, everyone. That concludes our full year and fourth quarter earnings conference call. Please note that our first quarter 2011 conference call is currently scheduled for Thursday, April 28 at 8:30 a.m. Eastern Time. We appreciate your interest in O-I. Again, thank you, and have a good day.

Operator

This concludes today's conference call. You may now disconnect.

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