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Executives

Edward C. White - Sr. VP and CFO

Paul Butts - IR

Albert Stroucken - Chairman of the Board, CEO

Analysts

George Staphos - Banc Of America Securities

Panjabi Ghansham - Wachovia

Tim Thein - Citigroup

Claudia Hueston - J.P. Morgan

Richard Skidmore - Goldman Sachs

Joe Stivaletti - Goldman Sachs

Sangita Jain - Lehman Brothers

Chris Manuel - KeyBanc

Mark Wilde - Deutsche Bank

Owens Illinois, Inc. (OI) Q4 FY07 Earnings Call January 31, 2008 8:30 AM ET

Operator

Good morning my name is Chandra and I will be your conference operator today. At this time I would like to welcome everyone to the OI fourth quarter earnings release conference call. All lines have been placed on mute to prevent any background noise. [Operator Instructions] Thank you. Mr. White, you may begin sir.

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

Thank you Chandra. Good morning from a cold and wintery Perrysburg, Ohio. On today's call we'll cover fourth quarter and full year results from 2007. With us today is our Chairman and CEO Al Stroucken, our Vice President for Investor Relations Paul Butts, and several other members of our senior management team. Paul will begin with a review of the company's position on forward-looking statements. I will follow with a summary of our financial results and then Al will talk about recent developments in and outside the company and provide some insights into our plans for 2008 and beyond. Afterwards we'll be glad to take your questions. Paul?

Paul Butts - Investor Relations

Thanks Ed. We'd like to remind you that in discussing the company's performance today, members of management may make forward-looking statements within the meaning of the Section 21E of the Securities Exchange Act of 1934 and Section 27A of the Securities Act of 1933. Such statements relate to future events and expectations that involve both known and unknown risks and uncertainties. The company's actual results or developments may differ materially from those projected in the forward-looking statements. For a summary of the specific risks factors that could effect results please refer to the company's most recent 10-Q and 10-K filings with the SEC.

The company does not assume any obligation to update or supplement any particular forward-looking statement made during the call. Also during the call, members of management may refer to certain non-GAAP financial measures. Information regarding these non-GAAP financial measures as well as a reconciliation of the non-GAAP to GAAP measures is available on the OI website. Yesterday after the market close, the company released its fourth quarter and full year results. The earnings release stated that additional information will be posted on our website. Ed will refer to charts this morning to help illustrate and reconcile results with prior year. For your reference I have also included an additional slide at the end of the deck to show the comparison, of reported versus continuing operations for some of the key 2006 financials.

If you've not already access these charts, you can go to our website at www.o-i.com click on Investor Relations and look for the charts under the events and presentation section, chart numbers are in the lower right hand corner. Ed?

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

Thanks Paul. We are very pleased to begin by telling you that our results in 2007 was the best we've reported since OI returned to the New York Stock Exchange, 16 years ago. Like every other quarter in 2007, fourth quarter earnings saw a tremendous improvement over the prior year and exceeded even our own expectations. We are very proud of these accomplishments and are looking forward to sharing some of the highlights with you today. For those of you who following the website chart, you will see that we've outlined some financial highlights for the fourth quarter and for the full-year on that first chart.

The most telling indicators of our significant and substantial turnaround was the consistency in our quarter-over-quarter improvements from our 2006 base. In both the fourth quarter and the full year we experienced double-digit increase on the revenue line and markedly improved operating profit and operating profit margins. I would like to point out also that the increase in reportable segment operating profit for 2007 at $370 million above the previous year was three times greater than the operating profits of our divested plastics business. The plastics business was quite profitable and some feared we would be crippling our own ability to grow by selling that business. Clearly, this has not been the case.

Now let's move to the more detailed reconciliation charts. Starting with charts number three. These are the reconciliation between GAAP and non-GAP earnings. We took the... we took two special charges in the fourth quarter. First, an asbestos charge for $115 million reflecting the result of our annual in-depth review, I will discuss this issue in more detail shortly. Second, an after-tax charge of $29 million for ongoing global profitably and footprint realignment study. The majority of this charge reflects the ongoing impact of decisions in Europe that we mentioned during our last earnings call. The balance is due to the plant closure in Canada that we announced earlier this month.

Let me review for you the guidance we shared last quarter on our footprint realignment. The charges associated with this global review process would likely continue through the first quarter of 2009 and will be influenced by market conditions and the outcomes of customer negotiations. Approximately, 50% of these charges will represent cash cost while the other 50% will be balance sheet adjustment. And finally, the total pretax charges anticipated from this global review should not exceed $150 million. We have already recorded $100 million that leaves a potential for another $50 million in future charges.

Now let's move to the financial results from operations starting first with our sales reconciliation on chart number four. The largest contributor to the $258 million sales increase in the fourth quarter was something we did not have control over, the translation of fact of strong foreign currencies against the U.S. dollar. I don't complain about this benefit but we recognized that we can't take credit for it. But what we can take credit for are the improvements in our price and product mix over the course of the year. The price and product mix percentage increased every quarter in 2007 beginning with a 4% improvement in the first quarter and increasing to almost 6% in the fourth. For the full-year 2007, total sales increased by 5% due to price and mix improvement. In 2008 we expect to see similar year-over-year improvements every quarter while remembering the global average impact those that captures specific market and customer situations.

Now, the only metric in which we do not see increases in the fourth quarter was volume, which we had anticipated. Clearly, we would like to see continuous volume grow but when we initiated our strategy of emphasizing price over volume, we expected that we may see some minor volume losses. Having said that, if you look at sales volume over the full year, you see that it increased 2% over 2006 and we remain headed in the right direction. Let me remind you that the profit benefit from 1 percentage point in price is equal to 4 or 5 percentage points in volume across most of our businesses.

Now let me turn to the segment operating profit reconciliation on chart number five. Consolidated operating profit in the fourth quarter at $284 million was almost double the fourth quarter of 2006. The chief contributor was price and mix, which netted the business a $95 million increase in the quarter over last year. This was partially offset though by a $51 million increase in input cost inflation in the fourth quarter over the prior year.

During the quarter just ended, we saw both the highest dollar and the highest percent increases of 2007 and this is an indication of strong input cost headwinds for 2008. So we curtailed production in the fourth quarter to maintain a better balance between supply and demand. As a result, production volume was down in the quarter compared to the prior year. Consequently, the year-over-year profit benefit in the fourth quarter was smaller than in the prior three quarters of 2007, when productivity and production volume together contributed a $75 million improvement over 2006.

In the fourth quarter productivity was continuing at the high levels achieved in earlier periods and was offsetting the lost fixed cost recovery of those selected production lines which were not scheduled. The $54 million fourth quarter improvement in warehouse delivery and other costs is partially attributable to improvements in our 2007 supply chain management, as well as some favorable adjustments resulting from our European SAP roll out. These were one-time adds and that’s something we expect to be repeated quarter-over-quarter.

Operating expenses in the fourth quarter were lower than prior year in part because we are no longer paying the high consulting and deployment cost that were associated with the high point of the European SAP roll out activity in 2006. Currency translation was the last significant positive in the fourth quarter profit reconciliation. It contributed $25 million to the year-over-year profit improvement. The euro, the Australian dollar and several South American currencies are all experiencing record highs against the U.S. dollar.

And I'd like to make one last comment about chart number five and refer you to a line near the bottom of the page captioned retained corporate cost and other. For the last couple of years the amounts on this line averaged between $25 million and $30 million per quarter. This was when we were operating two business segments, glass and plastics. Our new segment reporting approach will present OI’s global glass business units on a geographic basis, since we no longer have a plastic business segment. So going forward, we will have four segments, Europe, North America, South America and Asia Pacific.

As a result we made some minor changes to make it easier to compare business units and to bring closer alignment between internal and external reporting. We've done this by changing some corporate allocations. The result will be a run rate for retained corporate and other cost of about $5 million to $10 million per quarter lower than in prior years.

Now to see the impact of items below segment operating profit, let's move to chart number six, which is the EPS reconciliation. As you all know, we used the proceeds from the sale of the plastics business in 2007 to pay down debt. As a result interest expense in the second half of this year was considerably lower and it netted an increase in EPS of $0.04 for the quarter and $0.06 for the year. Minority interest for the year was a record high $59.5 million. For the most part this reflected the excellent results we are seeing in our South American operations, which we must share with our minority partners. Therefore the higher minority interest lowered earnings by $0.02 per share in the fourth quarter and $0.09 for the full year.

We benefited greatly from a reduction in our operating tax rate from 40.3% in 2006, down to 24.4% in 2007. This is attributed to our improved 2007 profitability in Europe and North America which created a very favorable earnings mix for our operating tax rate and added $0.29 per share for the year. Given the expectations of continued high levels of performance from these two regions this lower effective tax rate should continue as well into 2008.

Let me our finish our financial highlights by talking about our cash results. Chart seven shows our capital spending trends over the past five years and our continued capital discipline. Beginning in 2006, you also see the approach we used to account for the cost of our new plant in Lurin, Peru, which we financed through a capital lease. In chart eight, you see our ongoing success in managing working capital. We've made a concerted effort to encourage our global sales and manufacturing teams to take responsibility for better co-ordination between production planning and sales forecast. This effort has proven quite successful. At year-end 2007 management working capital as a percent of last 12 months sales was 18.6%, a 17 basis point improvement over year-end 2006. Based on the average of the five measurement points for 2007, management working capital improved by an average of 140 basis points.

Now let’s turn to charts nine and ten and look at the progress we are making in terms of our asbestos liability. At the end of the third quarter last year, we told you about our new proactive legal strategy to reduce litigation risk and to accelerate claim settlements under favorable conditions and circumstances. As you will see in these two charts, this approach is proving to be successful but before I review the key measures, let me remind you that the fact pattern on this issue has not changed and here are the key facts. This coming April marks the 50th anniversary since we sold the business that was a minor participant in the manufacture of high temperature installation blocks that contained asbestos fibers. Today, the average age of new claimants with a serious illness is 78 and our filings in the ordinary course continue to decline year-over-year.

Let's look at chart nine. Here you see there were approximately 9,000 cases filed in 2007, 2,000 more than the previous year. This increase can be attributed to our efforts to seek out cases, which qualify for settlement under our terms and conditions. These conditions include, the individual [inaudible] and he or she was exposed to our product between the years 1948 and 1958. If for not for this proactive strategy, we believe we would actually had fewer new filings in 2007 than in 2006. Now let me look the map between the left and right side to this chart. You have the 9,000 new filings during the year to the 19,000 pending cases at the beginning of 2007 and you can see that we disposed of 14,000 cases during the year 2007 and we ended 2007 with a ten-year record low for the number of pending cases at 14,000.

Chart number 10 shows both the increased cash outlay and the very significant benefit achieved to this proactive strategy. In the left panel you see that the cash payment history has been declining 5% to 10% a year until 2007 when we increased payments to $347 million. Let me explain how we use this cash. In round numbers, the first $150 million was the expected ordinary course outlay. The next $50 million was the reduction in the committed but unpaid liability, which is now less than $35 million and the balance of the asbestos cash payments, some $145 million was used to accelerate settlements of claims on favorable terms while achieving a major reduction in litigation risk. These objectives are met and on the right panel you see we succeeded significantly in reducing our asbestos liability for year-end 2007.

At $456 million our year-end balance is more than $230 million lower, that’s one-third lower than it was only one year ago. The liability bars are stacked to show the current portion in blue with the long-term portion divided between the pre-existing amount in red and the addition created by the most recent reserve analysis in yellow. The current portion of the liability at year-end 2007 is $210 million, which is also the estimate of our 2008 cash spending. We expect that two-thirds of this will be consumed in the first half of 2008.

As a final comment on chart 10, I would like to point out that we recorded in 2007, the smallest reserve charge for asbestos since 2003 when we began the annual in-depth review with the rolling three-year forward analysis. I spend more time today on the asbestos topic than normal and it is important for you to understand that we were a limited participant in the asbestos installation market and I want to reinforce that it has been 50 years since we exited that business. As a result our liability is declining and becomes more manageable every year.

Let's switch to free cash flow and look at chart 11. In 2007, free cash flow was and $330 million despite the effect of the accelerated asbestos payments I just talked about. This result exceeded guidance given on our earlier calls. It exceeded our own expectations, not to mention free cash flow exceeded any amount generated in the past 16 years. And this takes me to the last chart, I will reference today, chart number 12, debt maturity. When comparing 2006 and 2007 schedules on chart 12, you should first note that our total debt is now $1.8 billion less than the previous year. You can also see on the 2007 schedule the smaller amounts due and their extended maturities. In a time of uncertain credit markets, you can see that OI is well positioned for the next several years and while we would prefer to refinance the $250 million of senior notes due in May of this year if market conditions are not to our liking, we will have the flexibility to simply retire the note with operating cash flow generated during 2008.

I have to tell you, I’ve worked for this company almost my entire professional life. I've been here in the good days and I've been here when things were not so good. I have seen it publicly traded, I have seen it privately held and I've seen a lot. But I don't think I've ever been prouder of this company and the people who work here than I am right now. What the team has accomplished this year has been astounding and for the most exciting thing for us is that we feel this is just the beginning. There are so many more opportunities, opportunities in terms of markets, productivity, innovation all of which will increase earnings and build increased values for our stakeholders.

These are what we are expecting for 2008. We expect that pricing increases will continue to outpace inflation. As we are negotiating contracts on a global basis we are finding that our customers are accepting what in some cases were long overdue correction. And I will talk more about this shortly. We expect the impact of Lean Six-Sigma to start showing up on our balance sheet and in our earnings. Our first wave of black belts has graduated and their accomplishments have been notable and measurable. Meanwhile, the deployment champions are busy training several waves of green belts. We are expecting solid financial improvements to be generated to the work of all these teams. Now we do not expect a material increase in our operating expenses but there will be an upswing in our marketing and R&D spending which again I will expand upon.

Finally, the cash flow improvements for 2008 will occur in the back half of the year because we expect asbestos and capital spending projects to be larger in the first two quarters of 2008 compared to 2007. We believe that components are in place for continued cash flow improvements in 2008. We expect the amount to exceed $425 million, of course this is a very early view with a lot of moving parts in the business and the global economy.

That wraps up my prepared comments for today. As I've said already I’m enormously proud of what the company has achieved over the past year and I think 2008 has other great achievements in store.

Now, let me turn the call over to Al.

Albert Stroucken - Chairman of the Board, Chief Executive Officer

Thank you Ed and good morning to all of you on the call. We often start these calls by saying it's a pleasure to be with you but I can assure you that it truly is a pleasure today. And as you've seen from our release and heard from Ed's comments, we had a very positive fourth quarter and a highly successful year.

When I started here a little over a year ago, I knew OI had the potential to achieve these kinds of results. But even I did not realize we would improve so quickly. As is so often the case, many factors have contributed to our success. And clearly the most important factor has been the people. I am most grateful and somewhat awed by how fully our employees and our management team have engaged in this turnaround. Despite several years of turmoil and uncertainty, they looked forward and not backward. They acted in concert [ph] as one OI. Because of what I've experienced this past year, I know we're capable of much, much more. I'm confident that this is just a beginning and that we will continue to see OI grow stronger and leaner.

So how did our team achieve this success? We did it through manufacturing efficiencies, key leveraging our balance sheet, operating cost improvements, pricing disciplines, and procurement initiatives. We also benefited from currency developments. These factors all contributed to the fourth quarter and full-year results. All regions participated in making 2007 a great year for OI. While there are still considerable performance variations from region to region today, we have a much better perspective on why these regional differences exist. And as a result, we are now in a better position to replicate successful systems and process improvements from one region to another.

There are enormous challenges in running operations in so many parts of the world. But undoubtedly one of the advantages is being able to benefit from the experience of others. Today, North America remains the region with the greatest need for improvement along several dimension, productivity, operational flexibility, cost structures mainly influenced by labor and health insurance costs and unsatisfactory pricing levels. It is a tall order but I know we have the examples, the experience and the right people to do it.

In Europe, we have now largely completed the integration we began in 2004. Our focused efforts in Europe and our capital investments there are beginning to provide the company with considerable bottom-line improvements and benefits in the overall tax structure. In our last earnings call, I mentioned that we would be engaged in a considerable number of contract negotiations during the fourth quarter and beyond with our European customers. So far, it appears that our discussions are going well.

However, we will have to see how the first quarter unfolds before we make any conclusive statements. But based on the tone and tenure of the negotiation on which I’ve received feedback, it looks for the most part like our customers realize that they have been enjoying several years of very advantageous condition. They acknowledged that price adjustments are well supported by the inflation that has taken place over the last couple of years. And this is very important to us because we are well over a 100 glass competitors, strong competition from metal and plastic manufacturers, and a widely distributed customer base. Europe represents one of the most competitive environments in which we operate.

We now have collected enough information to better understand the market and there are some preliminary conclusions on how the customers are responding to our rationale and logic. They see the value of our offering even at a higher price level. As you have heard me say many times before, we will sacrifice volume to get to a performance profile that is more reflective of the value our products bring to our customer. When we began our global review of operations last year, we recognized that defections were a possibility. As we try to correct the imbalance that has developed over the years in some of our long-term commitments we are bound to have some customers that will not accept the level of price increases that we need to return the business to an acceptable level of profitability.

Despite our long-term relationships, some have elected to switch suppliers for what we believe to be an opportunistic short-term advantage and there will be instances where our customers business decisions along with other factors will have an impact on the conclusions that we must draw in managing our global manufacturing footprint. This was the situation in Canada, where we recently announced the closing of our plant in New Brunswick. Fortunately, we have not seen a lot of this and the overall impact [inaudible] revenue base has been minimal. Over the next five quarters, there will be additional capacity moves that will result in curtailment charges. As Ed mentioned in his remarks, we remain comfortable with the numbers we attributed to our footprint realignment in last quarter's call.

Now let me talk a bit about our capital structure. With the sale of our plastics business in mid-2007 on our improved cash flow, reducing debt, and improving our capital structure were our first priorities. I'm very pleased with the progress that we've made on this front and I believe that some further delivering will both increase shareholder value and give the company better financial flexibility. So now that we've guided our ship and are heading on our successful course I want to talk about industry leadership because this is where we are heading and some may put us at the top already but there are still a number of things that we need to do to secure our position as the leader we want to be in the global glass industry. Over the course of 2007, we helped our customers launch more than 250 new products around the world representing about 5% of our total volume. And at this point in time we have over 700 projects in the development pipeline. These numbers demonstrate that the glass continues to be a dynamic market but I'm also sure that we can and must do better.

When we talk with our customers about value pricing, they rightfully fully expect that we will create more value for them in return. As a result, we must step up our leadership and product and design innovation to complement our leading position in manufacturing technology. Over the course of this year you can expect to hear more about the more focused and metrics driven approach we are taking in this area. And suffice it to say to say that an ongoing innovation must become a fundamental attribute of our business model.

We are encouraged by the results we are seeing as a rollout of Lean Six-Sigma continues. The magnitude of benefits for project has ranged from several tens of thousands of dollars to close to $0.5 million on an annualized basis. We have identified several hundred projects that we expect to execute over the next 12 months. To ensure that those benefits make it to the bottom line we are developing a strong and sustainable productivity competence. We believe that implementing Lean Six-Sigma methodology gives our global and regional teams a competitive advantage that will be difficult to match. We will keep you updated about our progress in this area in the coming year.

Now, I'd like to talk a bit about the economy. Over the last couple of weeks we've been hearing and reading a lot about the future state of the U.S. economy. As always there are quite a range of projections from outright possession to slowing growth. Naturally, a lot of what we hear and read has a very U.S. centric bias. For our business, however we have to keep in mind that less than 25% of our volume is sold in the U.S. Discussing our global operations by region will offer a more accurate view of what we expect in 2008 but before I do that let me talk about the glass industry in general.

Since I'm fairly new to this business and to satisfy my own curiosity, I reviewed the historical performance of the U.S. glass industry during periods of recession. And I have come to the same conclusion that many of you have that the glass packaging business does not appear to have a strong correlation to the U.S. macro economic climate. It appears that it is mostly impacted by customer driven events and consumer buying decisions. And also the packaging sector's history shows that it typically outperforms the S&P 500 during times of recession. So that's good news.

Now let's look at the regions. In North America, market demand for glass remains strong in 2007 with the most to growth coming from beer followed by wine and spirits. Food continued to be impacted by the substitution. Glass improved its position in the beer segment as the preferred packaging material for premium brands and undiscounted sales while cans were used to promote lower-priced offerings.

In 2008, we expect our beer customers in North America to offer several new product packets in glass similar to what we experienced last year. In Europe, demand and supply is fairly balanced at the moment, which is a departure from the past when there was at least a perception of oversupply. This more balanced situation has helped improve the negotiating climate with our customers. We do need the strongest price corrections in Germany, Italy, the Netherlands, and the U.K. and as a result we are seeing most of the efforts to switch to alternative suppliers and perceive the strongest competitive pressures in those countries along with some resulting volume erosion.

The Central European economies are showing good growth and average per capita consumption while still substantial is narrowing in comparison to Western Europe levels. In addition, many large food companies are moving their filling capacities to Central Europe, also if beer and soft drink demand in that region continues to grow at its current phase, we don't see the new beverage can capacity announced in 2007 and more recently creating undue market pressure.

In Asia-Pacific, demand is also buoyant and we do not expect that slowing economic conditions will have a substantial impact on that demand. The persistent drought conditions in Australia however are having an impact on the hydroelectric cost as well as on the grape harvest. New Zealand on the other hand is seeing a very solid wine and beer business and the weather has not been an issue. China remains intensively competitive with some local competitors driven by full employment and different return on investment expectations than we have. Fuel and raw material cost in China continue to escalate and we recently saw some government intervention in fuel prices. All of this makes for a challenging market but with a population of 1.3 billion, China continues to be very attractive in terms of opportunity.

In South America, the markets in which we participate remain strong. Our South American business does not yet depend a lot on international markets and exports. Strong marketing and new product development activities in Brazil, Colombia, and Peru are leading the region in growth initiatives. Our Board just returned from a visit to our new facility in Lurin, Peru, which together with its sister facility in Kiao [ph] is operating in the top of our global rankings. And we are very encouraged by our prospects in this region. The high rate of inflation in Venezuela is likely to continue with price controls for some food and basic materials already in place but in general we expect this region to continue the positive development that we have seen over the last five or six years.

In the near term therefore, we do not expect fundamental change in the key parameters that drive our business on a global basis. That means that we will be able to continue on our path of margin improvement and maintain the momentum that we have gained over the last 12 months. We expect that 2008 will be a good year for our company and a period in which we begin looking further into the future and strengthening our role as a global industry leader.

Our plan is to focus on four strategic areas. First, marketing will have to become a core competency for the company. As we strive to maximize the value of our products, we need to better understand how to deploy our resources to provide added benefit to our customers and how to better support their marketing efforts. That will also give us a much better way to quantify the value our products and services represent for our customers and their end users. Second, we must change our innovation profile more quickly to take advantage of market opportunity.

We can strongly differentiate ourselves from direct and indirect competition in the rigid packaging market. We will do this by offering our customers unique packaging concepts and the ability to swiftly change packaged designs to take advantage of market opportunities. Nanotechnology and other advanced capabilities in the areas of printing, laser etching, temperature sensitive materials, and UV absorption can be incorporated in our developments.

Third, our manufacturing operations and our productivity gains will need to complement and support this emerging business model. We will use our competitive advantage in manufacturing excellence to become more flexible in our operations. This flexibility will also enable us to lean out our supply chain and logistics profile and will lead to lower working capital requirements.

And fourth, we want to drive our free cash flow to above 50% of our EBIT and reduce our debt to below two times EBITDA. That will give us a financial profile that will allow us the flexibility to navigate difficult market conditions and the freedom to fully participate in future growth opportunities while maintaining a strong capital structure. We will concentrate our use of capital resources in those countries and regions that have promising growth profiles and provide opportunities for geographic expansion. China, Mexico, Argentina, South Eastern Europe, and Eastern Europe are key areas for future growth. Besides acquisitions, the opportunity for Greenfield capacity additions in our established Latin American and other high-growth markets are likely to be part of our growth initiatives. However, we're cognizant that we must continue our efforts to reduce the required capital per ton of newly installed capacity at these new facilities.

And lastly, let me talk about what we perceive to be the greatest opportunity for the expansion of our market, the value of glass as a packaging material in a world that is more attuned to sustainability. In addition to its high consumer preference in the areas of purity, flavor preservation and product safety, glass is one of the most sustainable eco-friendly packaging materials on earth. Glass packaging can serve as an important component in any customer's sustainability story. We believe that this offers us significant opportunity to grow as we consistently find brewers and soft drink manufacturers who promote and advertise their products in glass packaging but deliver a significant proportion of their products in other packaging forms like polyethylene terephthalic or aluminum. And watch for this, the next time you see a beverage commercial or a billboard.

Just as our customers are doing we too need to promote the emotional appeal of glass more aggressively to the consumer and we have both the responsibility and an opportunity to raise awareness about the safety and health benefits of our product. Glass is made from raw materials of which there is an almost inexhaustible supply. Glass containers can be returned, washed, and refilled over and over again. The average for returnable bottles is 30 times and at the end of that performance cycle glass can be recycled. No other commonly used packaging material can make that claim. And even in the case of non-returnable, glass packaging can be made from 100% recycled material. It's infinitely recyclable into new packaging as pure as the original without any known risk factors in any end of useful life scenario. And these are facts based on glass being used as containers for more than 3,000 years.

This is really another area where we can show leadership in the industry. We will start promoting the unique benefits of glass more frequently and intensely. It will take time to have an impact but the trends and the consumer awareness will be significant allies in our efforts. So we've completed a very successful year and we are confident of continued success in 2008. You will see us begin to act more like a leader and we're optimistic that the products, the technology, and service we are bringing to our customers will ensure a bright future beyond 2008.

Now, Ed and I would be glad to take your questions.

Paul Butts - Investor Relations

We have taken the time to provide more detail on our remarks this morning so to provide for the broadest possible Q&A participation, we ask that you limit your questions to one with only one follow-up and then get back into the queue. Thanks.

Question and Answer

Operator

Thank you. [Operator Instructions] And your first question comes from the line of George Staphos, Banc Of America Securities.

George Staphos - Banc Of America Securities

Thanks operator. Good morning everybody.

Albert Stroucken - Chairman of the Board, Chief Executive Officer

Good morning George.

George Staphos - Banc Of America Securities

Congratulations on the year and the progress thus far and good luck in 2008. My few questions, first-off Al on your free cash flow and leveraged goals, which were terrific when do you think you will be able to hit such target? Does 2008, reasonable perhaps even on the free cash flow target or are these longer-term objectives? The second question I wasn't clear on your pricing discussion, are we to assume that the year-on-year pricing changes that you have seen in 2007 continue at a similar rate or my takeaway was we'll see continued acceleration by quarter on pricing in 2008? Thanks.

Albert Stroucken - Chairman of the Board, Chief Executive Officer

Well I will take the last point first. As you have seen already in the course of this year a acceleration of our pricing improvement…

George Staphos - Banc Of America Securities

Right.

Albert Stroucken - Chairman of the Board, Chief Executive Officer

And of course that will give us a base also moving into next year. So automatically the first quarter will show a more significant price improvement over the first quarter than perhaps the fourth quarter and the coming year will show the fourth quarter of 2007. But we are as I indicated using Europe as the model and from what I'm hearing so far it looks very positive. So I would certainly expect continued progression in our price development in a very positive way and I'm very positive and that of course is also the key driver for our free cash flow as we move forward. I believe that we have seen in 2007 that we have generally been able to do better than we assumed with our free cash flow objectives and I would certainly expect that the $425 million is going to be the low benchmark going into the 2008.

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

George, this is Ed, to kind of work the math, if you have $425 million as your free cash flow, if you take 80% of that, it is going for debt pay down and you’ve got high EBITDA, we will be achieving debt-to-EBITDA ratio by the end of '08 and then it's a matter of getting the... all the other ratios probably in that '09 period.

George Staphos - Banc Of America Securities

Okay. Thanks, guys I'll turn it over.

Albert Stroucken - Chairman of the Board, Chief Executive Officer

Thanks.

Operator

Your next question comes from the line of Panjabi Ghansham, Wachovia.

Panjabi Ghansham - Wachovia

Hey guys, good morning.

Albert Stroucken - Chairman of the Board, Chief Executive Officer

Hi, Ghansham.

Panjabi Ghansham - Wachovia

Hey, you know looking at the quarterly progression over the last few years, it looks like 1Q and 4... 2Q and 3Q are about 50% to 100% higher than 1Q and 4Q. I understand it's a broad range but using the fourth quarter sort of as a benchmark I mean you obviously benefited from currency but all things considered why shouldn't we expect EPS of $5 in '08. Is there anything [inaudible]

Albert Stroucken - Chairman of the Board, Chief Executive Officer

You’re pretty confident. Well, I think it's admirable to set high targets and high objectives and I'm certainly a promoter of that in our own company but I think we also have to make sure that we understand that we are not operating in a vacuum and so we are going to... have to go through quite a bit of hard work to really get the physical implementation of what we perhaps mentally can think as possible and I think it is unfair to an organization to set the target so high that it becomes virtually impossible to reach them. I believe that our… I was very clear in the beginning of the last year that certainly in the long-term we expect the margins that may come close to what you're talking about but I think it's going to require more time than just one or two quarters more.

Panjabi Ghansham - Wachovia

Okay. And just looking at to segment... your operating profit by segment across the geographies, big improvement obviously in Europe, decent improvement in Asia and South America and North America has improved but is there any structural reason why margins in North America can't approach at least European levels over the next few years? Thanks.

Albert Stroucken - Chairman of the Board, Chief Executive Officer

I think that question has two dimensions to it. Number one, why are we where we are and I think certainly a lot of that has to do with our contractual obligations that we have lamented in the past couple of years sufficiently, so I don't have to repeat them but the problem is it still is going to require for these contracts to elapse before we can take the corrective steps that are required but even under the that scenario if we look at the performance difference that exits from region to region and we look for instance at Latin America where we are most successful, I don't really see a very valid reason other than that things gradually developed that way why there should be such a fundamental difference because we are basically all dependent on a fairly unique and global raw material base, we are all dependant on the same energy and that has certainly globalized over the last couple of years. So, I believe you're pointing to an area there where there is a certainly for the future significant opportunity to take corrective actions, but the timing of that will depend on the contractual commitments that we have made in the past.

Panjabi Ghansham - Wachovia

Okay. Great. Thanks so much.

Operator

Your next question comes from the line of Tim Thein, Citigroup.

Albert Stroucken - Chairman of the Board, Chief Executive Officer

Yes Tim.

Tim Thein - Citigroup

Can you hear me?

Albert Stroucken - Chairman of the Board, Chief Executive Officer

Now I can.

Tim Thein - Citigroup

Oh, hi. Good morning. My question was first on if you can circle back to what Ed said. I just had a little hard time hearing you there in terms of your expectations, I think you gave a cost expectation for what you think material cost, is that what you said?

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

What we said Tim is if you looked at that $50 million year-over-year inflation hit in the fourth quarter, you see that as an indicator of probably before of what we would see next year for inflation and given that, I think there is still more inflation to come. We were looking at something that could actually be a double of inflation year-over-year between '07 and '08.

Albert Stroucken - Chairman of the Board, Chief Executive Officer

I think and what we're seeing and perhaps that's important as well for you as you look at the future, we are seeing a differentiated impact. We're seeing Europe and Asia Pacific to have a much greater level of inflation in the coming year than North America. Some of that is of course due to the fact that Europe as well as Asia-Pacific are more tied to the oil pricing rather than in the United States where we have a very strong tie in to natural gas. And we certainly expect that energy cost as well as transportation cost in Europe and Asia Pacific are going to be significant drivers in the coming year.

Overall I also would be remiss in not mentioning that certainly raw materials because of the tightness in soda ash are going to be a significant contributor in the earnings pact. I think on a global basis raw material will have a higher impact on inflation than energy at this point in time from our projections.

Tim Thein - Citigroup

Okay. But presumably in terms how that oil cost flow through into natural gas in Europe, you... as you're discussing contracts for '08 presumably you can at least enter the conversation.

Albert Stroucken - Chairman of the Board, Chief Executive Officer

One of the aspects that we've driving very hard is to basically have the opportunity to correct also much faster if we see individual cost components galloping away. So, we do not have to wait until the end of the year to take some corrective action and we've been quite successful in many instances and got that included in the price negotiations for the coming year.

Tim Thein - Citigroup

Okay. Good. Thanks.

Operator

Our next question comes from the line of Claudia Hueston, J.P. Morgan.

Claudia Hueston - J.P. Morgan

Okay. Good morning.

Albert Stroucken - Chairman of the Board, Chief Executive Officer

Good morning Claudia.

Claudia Hueston - J.P. Morgan

I was just hoping you could talk a little bit more about productivity and efficiency gains and how we should think about sort of the timeline of those benefits coming through over 2008 and 2009, particularly 2008?

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

Well, we've already seen considerable productivity improvements in the past year and certainly as they have gradually been moving into the operations in the course of the year again, there is also some carryover that is going to help us in the coming year. But I also have to say that based on the discussions that we've had with various manufacturing people in our companies and in the regions that they all are confident that they can still continue with these productivity improvements going forward, so I would continue to expect productivity as well as pricing to be the drivers that is going to help us in our margin improvements in the 2008 period.

Claudia Hueston - J.P. Morgan

Thanks, that's helpful. And then I just have a quick clarification on the debt-to-EBITDA target that didn't include the asbestos liabilities. Right?

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

No, it did not… we’ll let everyone think what they want to say is their own kind of debt liability, debt like liability for asbestos.

Claudia Hueston - J.P. Morgan

Okay, thanks.

Operator

Your next question comes from the line of Rick Skidmore, Goldman Sachs.

Richard Skidmore - Goldman Sachs

Hi, good morning. Just two, Al, talk about the potential for pricing going forward as you compare glass pricing versus the other substitutes like cans and plastic. How much further can you go with regards to pricing relative to those other products and then how much further do you think pricing can go before you start to see people bring on new capacity and the supply demand balance gets disrupted?

Albert Stroucken - Chairman of the Board, Chief Executive Officer

To give you a meaningful answer I have to give you some additional background. Number one is our annual cap, the non-returnable packaging, the competitive dynamics are of course different than in the returnable packaging and now non-returnable are more strongly pronounced and developed in North America and in Europe and therefore in that area we are of course closely watching the competitive pricing and cost of cans and plastics and we are finding that we are still doing pretty well in that comparison. That in fact in quite a few areas, aluminum packaging is still more expensive than glass and I believe that bodes well for us because from what I'm hearing and reading in the alternative plastic packaging and metal packaging areas, they still are seeing some significant cost pressures as well going forward. So that will be supportive.

Now the other aspect is, if I look at returnable bottles, there just is no competitive cost pressure or cost comparison that makes any sense because there is no packaging that allows people to return the same bottle 30 times or in some cases as we find out in Latin America 50 times. And so the cost per usage of such a container is just unbeaten as far as competitive advantage is concerned and I think that's really where we still have a lot of opportunity.

Richard Skidmore - Goldman Sachs

Okay, and then I guess just a follow up. How long do you think this pricing story can go is it a couple of year process, a multi-year process?

Albert Stroucken - Chairman of the Board, Chief Executive Officer

Well, I think we still have some fairly significant contracts that are becoming only due in the next two years, so it's still at least going to be a two-year story.

Richard Skidmore - Goldman Sachs

Great, thank you.

Operator

Your next question comes from the line of Joe Stivaletti, Goldman Sachs.

Joe Stivaletti - Goldman Sachs

Is there... when you look at your free cash flow estimate for the year of at least $425 million, can you just summarize what goes into that assumption in terms of pricing... increase in pricing for '08 versus '07 summer I assume there is some assumptions there?

Albert Stroucken - Chairman of the Board, Chief Executive Officer

Well, of course the cash flow is determined by a quiet variety of factors. We have already indicated in last year... last year's conference calls that we were likely to increase our capital spending in the coming year so that is going to have a negative impact on it. We have productivity improvements, we have pricing we are working on our working capital. So trying to tie it to just one component is going to be very difficult, suffice it to say that of course our objective in the coming years is to have price corrections that are surpassing the inflation rate because we still have to make up for $600 million of inflation in the past couple of years that we haven't recovered.

Joe Stivaletti - Goldman Sachs

So, is there a way though... I realize there are a lot of other things that are moving parts. I just was wondering if your price increases are you're looking... you think we should be... if you give any guidance there you think we should be thinking this year at 3% or 4% or what?

Albert Stroucken - Chairman of the Board, Chief Executive Officer

Beyond what I told you, I think that's where my capability to give you meaningful guidance is limited and stops.

Joe Stivaletti - Goldman Sachs

Okay. And just to clarify. Similarly you talked about the cost inflation and you're making reference to the... I believe to the $51 million delta that occurred in fourth-quarter and said that, obviously there is some challenges in '08. Do you have a number that we should be thinking about? I didn't quite understand what you were saying when you said it could be double or something like that I mean for '08?

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

This is Ed, I'll jump in on that one. If you said $51 million was the fourth quarter that's... look at if you look at that as a run-rate multiply that time four, that would kind of put a floor of about $200 million of inflation for '08.

Albert Stroucken - Chairman of the Board, Chief Executive Officer

We think though at this point in time, we're most probably talking about the high 200s as an inflation rate.

Joe Stivaletti - Goldman Sachs

Okay. That was... that's very helpful. Thanks a lot.

Operator

Your next question comes from the line of Sangita Jain, Lehman Brothers.

Sangita Jain - Lehman Brothers

Hey, good morning. Thank you for taking my question. As you guys bring your asbestos liability down and your debt-to-EBITDA target number lower. Can you share with us your thought on a stock buyback and or a dividend initiation?

Albert Stroucken - Chairman of the Board, Chief Executive Officer

Well as far as stock buyback and dividends are concerned, we have to achieve our targets first before we get to the point where we don't know what to do with our money. I think at this point in time, we believe though that if we are going to perform in the future at a much higher level than we have seen in the past, we have an obligation to look at opportunities to take this model and expand this model geographically, expand this model into regions where we are not yet very significant. And I believe that would most probably require a lot of the available capital that we have either through acquisitions or through capacity expansions in strongly growing markets. So I do not foresee at this point in time that the two aspects that you were asking about will become active in the next one or two years.

Sangita Jain - Lehman Brothers

Okay, that's great. Thank you and I have a follow-up on your point about geographic expansions. Can you give me a little bit color on if there is a meaningful shift from two-way glass to one-way glass in some of these emerging markets as they become more prosperous if I can say that?

Albert Stroucken - Chairman of the Board, Chief Executive Officer

I don't think Sangita that that really is a factor in the future. In fact the strength of our position is that especially if you go into regions like China, India if you go in specific countries in Latin America where you have a significant part of the population with a income level on daily basis of $2 or less the packaging cannot be and is not allowed to be a significant cost of the overall offering. So these countries naturally tend to go to returnable bottles and we have a very high percentage in these regions sometimes 95, 97% is returnable bottles and a huge percentage of the returnable bottles actually make it back because due to an economic necessity that this system works. And I believe that really is the growth opportunity for us in the future because as I said early there is no competitive material that can really muscle in into this area.

Sangita Jain - Lehman Brothers

Great, thank you so much.

Operator

Your next question comes from the line of Chris Manuel, KeyBanc.

Chris Manuel - KeyBanc

A quick question for you, as you look ahead at 2008 where would you anticipate and now you're going to start reporting through different segments, where would you anticipate most of your improvement coming in ’08? Is it your new efforts to double back here in North America or do you anticipate the bulk of your improvement continuing to come from Europe, South America, Asia etcetera?

Albert Stroucken - Chairman of the Board, Chief Executive Officer

I think that from a timing perspective I think Europe is most probably going to be first out of the gate in the comparison with North America because North America, we still have this long-term contractual issues whereas Europe at much higher percentage about 70% of its volume was really not tied to very long contracts whereas in the U.S. it's exactly reverse. So I would say Europe is most probably as far as timing is going to concern to show the first significant improvement, as well as, Asia Pacific, because I think our colleagues in Australia and in New Zealand are doing a terrific job of going back to the margins, so that they used to enjoy several years ago and I think they made up more than half of the difference already last year, and I would expect these continued strong performance on their side.

Chris Manuel - KeyBanc

That's my question. Thank you.

Albert Stroucken - Chairman of the Board, Chief Executive Officer

Alright, thanks.

Operator

Your next question comes from the line of Mark Wilde, Deutsche Bank.

Mark Wilde - Deutsche Bank

Good morning and congratulations on a great fourth quarter.

Albert Stroucken - Chairman of the Board, Chief Executive Officer

Hey, Mark.

Mark Wilde - Deutsche Bank

I wonder Al, beyond moving prices up if you can talk with us just in general terms about what you're trying to do to change the nature of any contracts that you have going forward in terms of escalators or things like that?

Albert Stroucken - Chairman of the Board, Chief Executive Officer

Alright, I of course cannot talk about specifics,

Mark Wilde - Deutsche Bank

I understand that.

Albert Stroucken - Chairman of the Board, Chief Executive Officer

Philosophically what we are trying to do is shorten the time commitments of the contracts as far as pricing is concerned. I understand that many of our customers need a longer-term commitment as far as availability of products is concerned but that does not necessarily tie in automatically to a price commitment for the same period of time. So as a result what we are trying to put in place are shorter term pricing arrangements that also have for the more volatile cost components like energy, freight cost, raw materials and labor costs, certain pass-through provisions that act much more frequently than in the past so not every year but more likely quarterly and then also go to a more retroactive approach to this because we are basically just talking about pass-thoroughs.

And I think that is really from a directional perspective where we want to go. Now we understand that in some cases that creates some difficulties for our customers because they in turn have annual commitments and firm commitments in some cases so will we have to work from time-to-time with individual customers what would be giving them the best dynamics as well and in some cases just a trade-off of a net present value consideration that we will have to flow into the discussion.

Mark Wilde - Deutsche Bank

Okay, very good and if I could as a follow on Ed, the biggest delta that I saw in terms of the segment reconciliation was that warehousing and delivering, you made some comments on that. I just wondered if you could go back over that again because through the first three quarters of the year that had been a net negative number and there was a positive to the tune of about $53.5 million in the fourth quarter?

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

That's right Mark. What I said in my prepared comments, I’ll be [inaudible] here as we were going to SAP last year, we had some quarter-over-quarter lack of clarity and then as we are doing some of the clean up this year we picked up on that. So what was the numbers of the year are appropriately stated we had some quarter-over-quarter swing which I…say we’re just cleaning up on some classifications. So that's why I said it that they don’t, for the year they are find but next year on the fourth quarter you're going to see that kind of number coming back because there was just a clean up in re-class.

Mark Wilde - Deutsche Bank

How big would do you expect that the wages kind of going in to 08, what kind of a benefit?

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

We are making progress on our warehouse and shipping delivery. And as our inventories are getting lower, you don't have go rent at much space. If you're getting better at your job changes, you're making the bottles closer to where you wan to deliver them so your freight costs are going down. So we would… again if you look at that full year number that's the kind of direction we would be hoping for as we used get better at our whole supply chain.

Albert Stroucken - Chairman of the Board, Chief Executive Officer

We [inaudible] we still have well over 100 warehouses and generally warehouses tend to be full as I said before and I think still offers great opportunity to get impact on working capital as well as of course on expenses as well.

Mark Wilde - Deutsche Bank

Okay, thanks a lot. Congratulations.

Albert Stroucken - Chairman of the Board, Chief Executive Officer

Why don't we just take one last question, it’s already beyond 9:30 if there is one otherwise we will…

Operator

Thank you sir. Your final question comes from… a follow-up from George Staphos, Bank of America Securities.

George Staphos - Banc Of America Securities

Thanks guys. May be the last question, you had mentioned that you expect pricing to be more than inflation both energy and raw material this year. If we take pricing out of the equation it’s ultimately, that should yours and your shareholders. Do you think that your combined productivity effort whether it’s on warehousing or Lean Six-Sigma operational expense, etcetera whether that can offset inflation this year, round numbers, what ratio would it represent as we look after 2008?

Albert Stroucken - Chairman of the Board, Chief Executive Officer

I think in a typical year when we are running also within benefit… with a full benefit of Lean Six-Sigma I would expect productivity improvements of let’s say between 2% and 2.5% to be reasonable expectations. I don't think yet we are at that performance level. So I would say we would still follow a little bit short of inflation, but clearly as we move forward George that is an objective and the target because it gives us a much more secure position in our customer relations down the road.

George Staphos - Banc Of America Securities

Okay. One clarification and a follow-on 2% to 2.5% what are you measuring against that and then separately what volume effect should we consider just from the plant closure, not talking about the pricing model and what that might mean in terms of shifting or non shifting by your customers, but from the plant closing should we expect any volume fall-off? Thanks guys.

Albert Stroucken - Chairman of the Board, Chief Executive Officer

I would say at this point in time what we have been able to do is whatever we have taken out or planning to take out as far as volume impact is concerned, I think we have been able to through productivity improvements and streamlining of our SKUs enable to recompensate for that volume in the remaining facilities, which is of course one of the benefits of the productivity improvements. And I think that is also going to continue in the year going forward. Now with regard to individual regions depending a little bit on the profitability profile that may not necessarily totally in harmony between productivity improvement than what we would drop off but from a global perspective it's certainly is expected to be there.

George Staphos - Banc Of America Securities

And the 2.5% is mostly against what, the productivity?

Albert Stroucken - Chairman of the Board, Chief Executive Officer

The 2.5% is against our cost base.

George Staphos - Banc Of America Securities

Okay very good guys. Thanks again good luck in the year.

Albert Stroucken - Chairman of the Board, Chief Executive Officer

Okay. Thank you very much. Thank you for joining us on this call and Paul do you have couple of comments you like to make.

Paul Butts - Investor Relations

Yes, I just like to remind everybody and invite you to join us again on Thursday, May 1 when we have our first-quarter earnings call for 2008 and also hence up that we're planning an Investor's Day for later in May. So look for announcements shortly with the date and the details for that webcast. Thanks Chandra.

Operator

You're welcome sir and you have a great day.

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