Jul 17, 2008
Executives
Alan W. Rutherford – Vice Chairman, Executive Vice President and Chief Financial Officer Timothy J.
Donahue - Senior Vice President, Finance John W. Conway – Chairman, President and Chief Executive Officer
Analysts
Ghansham Panjabi - Wachovia Securities Christopher Manuel - KeyBanc Capital Markets Richard Skidmore - Goldman Sachs Claudia Shank Hueston - JP Morgan Timothy Thein - Citigroup Alton Stump - Longbow Research Mark Wilde - Deutsche Bank Securities George Staphos - Banc of America Securities
Operator
Welcome to Crown Holdings’ second quarter 2008 earnings conference call. (Operator Instructions) I would now like to turn the call over to Alan Rutherford, Executive Vice President and Chief Financial Officer.
Alan W. Rutherford
With me on the call this morning are John Conway, Chairman and Chief Executive Officer, and Tim Donahue, Senior Vice President, Finance. Let me point out that on this call, as in the news release, we will be making a number of forward-looking statements.
Actual results could vary materially from such statements. Additional information concerning factors that could cause actual results to vary is contained in our SEC filings, including comments in the section called Management Discussion And Analysis Of Financial Condition and results of operations in Form 10-K for 2007 and in subsequent filings.
In view of Regulation G, we do not intend to provide non-GAAP financial measures of performance on liquidity beyond those already contained in the company’s earnings release. I will comment on the results, Tim Donahue will then comment on taxes and foreign exchange, after which John Conway will discuss the quarter and the outlook for the coming year before we open the call to questions.
Total company revenues grew 10.4% in the quarter and 9.6% in the first half over prior year, reflecting strong volumes in beverage cans and firm volumes in food, along with the pass-through of higher costs in selling prices and foreign exchange movement. Segment income at $247 million in the quarter and $401 million in the six months grew 28% over prior year, generally reflecting improved margins in most of the segments of the business.
Americas beverage revenue at $501 million in the quarter was 3% higher than prior year and for the six months 4% higher at $918 million. Segment income improved marginally to $58 million in the quarter and for the six months as recorded a 6% improvement over prior year to $100 million.
Volumes in North America, that is U.S. and Canada, were flat in the quarter and six months compared to prior year, while volumes in Central and Latin America were softer in the quarter, it is the winter season, but flat year-on-year for six months.
In Europe beverage revenues at $476 million in the quarter and $824 million in the six months were 19% and 21% higher than prior year respectively, on improved volumes up 9% and 11% year-to-date. The increased volume and improved operating efficiencies resulted in segment income in the quarter increasing 52% to $88 million and 58% to $139 million in the six months over the prior year.
North American food revenues grew 4.8% to $220 million in the quarter and 1% to $405 million in the six months. Volumes for the business were soft, off 2%, however pricing was firm and operating efficiencies good, resulting in flat segment income at the half year point.
Food Europe reported a 19% increase in revenues in the quarter to $557 million and 14% year-to-date to $1.45 billion. This reflected stronger volumes in the quarter, up 4%, and a pass-through of costs in selling price.
Segment income at $61 million in the quarter improved 36% over prior year and at $102 million is 23% higher in the six months, reflecting price and volume. Specialty packaging revenues at $125 million were 12% higher in the quarter, reflecting pass-through of raw material in price and foreign exchange impact.
Segment income improved 22% in the quarter to $11 million and 20% in the six months to $12 million, primarily as a result of better efficiencies and cost reductions in the operations. Non-reportable revenues at $317 million grew 2% in the quarter and 4% in the six months to $637 million.
Segment income at $46 million improved 48% in the quarter, 37% in the six months, at $87 million, reflecting strong beverage can demand in Asia and improved results in aerosols worldwide. With regard to the company’s guidance for 2008, we stated in April that we expected segment income would increase in the range or 16% to 20% in 2008 over 2007, or to around $750 million to $780 million.
Based upon current knowledge and current exchange rates we now expect segment income to grow in the range of 24% to 28% in 2008 over 2007, or to around $800 million to $820 million for the full year. In April we projected free cash flow in the range of $330 million to $370 million, after capital expenditure of $170 million.
We now expect free cash flow to be in the range of $350 million to $390 million after capital expenditure of $185 million. The increase in capital expenditure reflects the foreign exchange impact on overseas investments and expected cash outlays for the recently announced beverage can line in Morocco, which although a 2009 project will require certain down payments on equipment in late 2008.
And with that I will turn the call over to Tim for his comments.
Timothy J. Donahue
I will quickly discuss taxes and foreign exchange and then I am going to hand it over to John so that he can discuss the highlights of the quarter and the half year. As noted in the earnings release, our effective tax rate in the second quarter was 25% compared to 17% last year and 28% for the six-month, which compares to 22% in the first half of 2007.
As we have previously described for you, the increase is attributable to the reversal of the valuation allowance on our U.S. deferred-tax assets, which was recorded in the fourth quarter of 2007.
Obviously the increased tax rate has had an impact on the percentage by which our earnings per share has improved, compared to the prior year. For comparison purposes, if we were to apply the 2008 tax rate to the 2007 results our 2008 earnings per share improved approximately 36% from 2007, comparable to the increase in segment income.
The translation of foreign currency amounts back to the U.S. dollar, how we report currencies, continue to impact our income statement, balance sheet, and cash flows.
From a balance sheet perspective the Euro was 17% stronger against the dollar at June 30, 2008, compared to the same period in 2007 and on the income statement our average Euro-to-dollar rate for the six months through June was 15% stronger than at the same period last year. Within the earnings release we have detailed for you the foreign exchange impact on numerous income statement line items, however, as much of our cost basis in these same currencies, including debt and interest expense, taxes, etc., the foreign exchange impact on net income is less significant than at segment income.
At net income foreign exchange has benefited us by $4 million, or $0.02 per diluted share, in the second quarter and by $6 million, or $0.04 per diluted share, for the six months compared to the same 2007 periods. And with that I am going to turn it over to John.
John W. Conway
As Alan and Tim reviewed with you, Crown had another excellent quarter. All of the businesses performed well in their various markets and the momentum for the balance of the year, we think is very strong.
Unit sales performance has been as we had generally expected, which is to say solid in the mature markets and very good in our emerging markets businesses. Price utilization has also been excellent and we have successfully passed through cost increases and in certain markets we have been able to improve margins as a consequence of very strong supply/demand fundamentals.
Our major capital projects for 2008, which are a doubling of our beverage can capacity in Seville, Spain, and building a new beverage can plant in Northeastern Brazil remain on schedule and within budget. Both new facilities will begin production late this year.
We have announced a new major capital project for 2009, which will be beverage cans for the Moroccan market, to be located in Casablanca. This is a market which we know very well and which we currently serve from our various Mediterranean Rim beverage can plants.
This is a strong market which we anticipate will continue to grow, in line with the region. As we look ahead into 2009, we have begun to advise all of our customers, particularly those which use steel packaging that prices will be going up sharply as a consequence of underlying raw material price increases.
We have no reason to believe that we will not be successful in passing through these increased costs. Our overall strategy, which has been to be an excellent performer in rigid metal packaging in all of the categories in which we are present, continues to be, in our view, very sound and we believe we are executing it in a highly effective manner.
We will continue to maintain good profitability in mature markets through efficient price adjustments associated with cost changes and through productivity improvements. We believe that our emerging markets businesses will continue to grow, possibly at alternating rates, but in a very positive manner which will enable us to generate increasingly substantial sales and income in South America, Eastern Europe, the Middle East, North Africa, China and Southeast Asia.
In summary, our prospects for 2008 are excellent and we intend to improve on them in 2009. And with that, that concludes our prepared remarks and we will open the session to questions.
Operator
(Operator Instructions) Your first question comes from Ghansham Panjabi - Wachovia Securities.
Ghansham Panjabi - Wachovia Securities
There is a lot of concern in the market that Europe is slowing significantly, or at the very least expected to slow in the near term. Can you, John, comment on what you’re seeing in Continental Europe, excluding the Middle East and Africa?
Is there any change at the end of the quarter versus the beginning of the quarter, in terms of trend, or any of your customers, in terms of sentiment, pulling back in terms of new product introductions?
John W. Conway
Ghansham, we have not seen slowing in the second quarter. The first half of the year in Western Europe was somewhat slower than last year but our view is the trend has been reasonably stable and as we move into July, July looks pretty good so far.
So, as I said earlier, we are very confident overall and we’re confident in particular about the businesses in Western Europe.
Ghansham Panjabi - Wachovia Securities
And in terms of inflation, you obviously have a big presence in Vietnam and you’re growing that. Inflation is running 25% a year, apparently.
Can you talk about how that’s changing your business model and some of the challenges you are seeing in that market?
John W. Conway
Well, you picked one of the markets which does have a significant inflation. It has not adversely affected consumption and we largely price in dollars and buy our principal raw materials, aluminum, in dollars, and so it has not adversely affected price, either, for us.
So in the case of Vietnam, the Vietnamese authorities are extremely concerned about it, they are taking measures to try to rein it in. A lot of it has to do with state-owned enterprises accessing capital that’s too cheap and too readily available, and so we are counting on that correcting.
Ghansham Panjabi - Wachovia Securities
So no change in capital plans there, then?
John W. Conway
No.
Operator
Your next question comes from Christopher Manuel - KeyBanc Capital Markets.
Christopher Manuel - KeyBanc Capital Markets
When you look at your balance sheet, debt levels obviously are trickling up a little, but that’s largely due to currency. At what sort of level are you comfortable with where the balance sheet is at?
Alan W. Rutherford
Well, obviously, Chris, our plans at the moment are to continue to de-lever the company as we go along here. In the past we’ve talked about trying to be below 3x or 3.2x levered.
Obviously what’s happening to us now is that our EBITDA number is increasing, along with the profits, of course, and at the same time we are continuing to pay down the debt. So really, we are still looking to be at 3 or around that number as a multiple.
And, also, we think at the moment it’s good to have liquidity. We still have a feeling that this is a market where liquidity is a good thing to have and that’s our view, that we should maintain as much liquidity as we can and keep the balance sheet and continue to de-lever it down to what I’ve just said.
Christopher Manuel - KeyBanc Capital Markets
With the prospect of Anheuser-Busch being sold and potentially the metal container assets coming to market, the balance sheet may be a little beyond where you would like it be but would if that property comes to market would that be something you would be interested in, and would your balance sheet preclude you from making an effort at that?
John W. Conway
Chris, both Anheuser-Busch and InBev are great customers; we serve them both in various parts of the world and so there has been some speculation as to what might happen in the future but we think it’s a little premature of us to begin to talk about what we might do if something happened and if something else happened. The very positive thing, that we think and I think you see in the numbers and the results, is our plan is working for us.
We are about the size we are in the mature markets to a large degree because that’s the size we want to be and we are applying our capital wherever we possibly can in the emerging markets, which were metal packaging and consumer metal packaging is where we think capital ought to go. So our plan is working great and we’re just going to defer the question of our interest for the future.
Christopher Manuel - KeyBanc Capital Markets
The last question I wanted to raise was with the prospect of tin plate going up sharply next year, I know you mentioned you’ve already spoken to a number of your customers about it. At some point does tin plate continuing to go up or steel costs continuing to go up at the pace they do, make some of the various products less competitive?
Whether it’s a steel bev can versus the aluminum counterpart, whether it’s the aerosol can, whatever the product. Do you begin to get nervous at some point or think about more conversions potentially from steel to aluminum, particularly in Europe?
John W. Conway
No, we don’t, because although we’re never happy to see any of the raw materials go up in price, in fact steel has lagged aluminum, we think has been lagging glass and petroleum-based resin, so we don’t foresee that as a problem and we think the market will take the increases and we are going to have to pass them through. Our customers know that; we’ve been very, very clear about it.
Recently in the United States and Canada we sent something in writing to all of our steel-packaging customers telling them very precisely about what was going on and giving them very early warning about the size of the potential increases that will be effective January 1, 2009. So, we’re not concerned about unit volume sales.
Not at this point.
Operator
Your next question comes from Richard Skidmore - Goldman Sachs.
Richard Skidmore - Goldman Sachs
Could you talk about Europe, in your European beverage can business, where your margins were up, it looks like about 400 basis points year-over-year? Can you talk specifically about what is driving the margin improvement?
I would have thought that margins would have been lower because of the raw material prices going up.
John W. Conway
Well, we had a variety of things happen, Richard. First of all, unit volume sales were up so utilization was much better.
Our factories ran much better. In the Middle East, for example, where as you know for the last five years we’ve added a lot of capacity, we continue to come up the learning curve in what are now some very substantial factories, so the more units you drive down costs sharply.
And we no longer have the drag of contracts that don’t allow us to pass raw materials through promptly. So, we have worked our way through all of those things and we’re just seeing the benefits, for us, reasonably good, a great demand environment in certain areas, and the results of all the actions I just described.
Richard Skidmore - Goldman Sachs
With regards to the Seville plant, is that a third quarter startup or a fourth quarter startup?
John W. Conway
No, it will be about November, so we will be coming up learning curve beginning mid-November or so.
Richard Skidmore - Goldman Sachs
The guidance that you mentioned of $800 million to $820 million of segment income, is that before the sort of the corporate line? Or is that after?
Alan W. Rutherford
No, that’s the total.
Operator
Your next question comes from Claudia Hueston - JP Morgan.
Claudia Shank Hueston - JP Morgan
I just wanted to ask about the non-reportable segment margins. They were up very nicely versus recent trends and our expectation.
Just wondered if you could talk about what drove that and maybe how we should think about those margins going forward.
John W. Conway
As Alan said in his comments, the two principal elements there, our Asian division and the aerosol business, and Asia was a story very much like Europe. Demand was strong for all of the products, beverage and food cans.
We have a fairly large food can business in Thailand. And pricing was good, we passed through all costs.
We didn’t have the drag as we have had in several prior years in China of prices where we were limited as to raw material price increase pass-throughs. The capacity we have been adding in Cambodia and Vietnam, we are utilizing more effectively.
So it was just a lot of good things happening pretty much across the board. Aerosols also did a fair bit better quarter-to-quarter, we were pleased to see that.
And that was also around the world, in North America, Europe, and Thailand. So, the two things were working in the same direction for us, Claudia, and that’s what you saw.
Claudia Shank Hueston - JP Morgan
Did you mention what the currency impact was in the European beverage and European food businesses specifically.
Alan W. Rutherford
Not specifically, no.
Operator
Your next question comes from Tim Thein - Citigroup.
Timothy Thein - Citigroup
First question was on, maybe you could comment on the tin plate and the prospect for significant price increases next year. Are you seeing any, and some of the reports have noted that some of the buyers, which I imagine doesn’t apply to you, but presumably the smaller buyers that have been put on allocation by some of the steel manufacturers, maybe you can comment if you are seeing a difference in kind of the discipline with regards to pricing in the market amongst your chiefly smaller competitors.
John W. Conway
Well, as to our steel suppliers, they are being very, very scrupulous about honoring contracts, but not doing one extra thing. And so we are tight on supply, also, not as tight as the small guys are, who have tended to be buying spot.
Because we’re contract buyers and we’re contract buyers so that we’re sure that we have adequate volumes to serve our customers and do what they’ve asked us to do over the course of a full year. But, yes, the steel industry, as tin plate products, but that’s our exposure, is highly disciplined and we do not anticipate there is going to be a buy-ahead like can companies this year as there has been in the past.
That is to say, we’re going to have to have a big increase effective January 1, 2009, and we’re not going to be able to drag it into the year and we’re telling everybody that’s what’s going to happen.
Timothy Thein - Citigroup
And back to Alan to follow up on what you said earlier with regards to the cash flow deployment. Have you changed your tune at all in terms of the ratio there?
Alan W. Rutherford
Not a lot, we’ve been talking about being down to $3.23. I think it’s pretty evident that our EBITDA is going to exceed $1 billion and that the net debt is going to probably be down below $3 billion, so by the year end we’re going to be on that number, if not better.
I think that’s the way we’re heading now at the moment.
Operator
Your next question comes from Alton Stump - Longbow Research.
Alton Stump - Longbow Research
With the steel plate increase, I know that there are some rumors out there from a couple of the suppliers that that might actually be a mid-year, calendar year 2008 increase. I assume with your comments that that’s probably not going to happen, that we will not see that go through onto the first of next calendar year?
John W. Conway
Well, all of the steel companies are vociferous in explaining to us, and I suppose to others, the terrible cost pressures they’re under, that they didn’t anticipate, and how badly they need increases. And we understand their plight, but our position is that we have made commitments, they’ve made commitments, we expect everybody to stick to them, at least to the end of the year.
And so far that appears to be the position that they’re prepared to take with us. Now, we’re contract buyers, we’re not spot buyers.
Spot buyers are in a totally different position. Their prices are going up dramatically and our smaller competitors, we see it in what’s going on in the market place.
Which, of course, gives us a lot of confidence that we’re going to be able to pass through any steel price increases for 2009.
Alton Stump - Longbow Research
Looking at the bev can business in Europe, obviously it’s been pretty easy weather comps year-over-year coming up in Q3. Can you put a bit of color on that, whether you think we could see volume get a bit better even the third quarter just because of those comps, versus Q2?
John W. Conway
Are you talking about weather for beverage, Alton?
Alton Stump - Longbow Research
Yes, in Europe.
John W. Conway
Alton, honestly, I can’t remember that specifically, all the circumstances of beverage in the third quarter last year. But we expect a very strong quarter third quarter in beverage and we hope and expect it will be very much like the second quarter.
Operator
Your next question comes from Mark Wilde - Deutsche Bank Securities.
Mark Wilde - Deutsche Bank Securities
Is it possible within the European beverage can business to break out that 9% volume gain? You mentioned that you were up about 25% in the Middle East.
Can you give us some color on sort of what on volume-wise in the other markets?
John W. Conway
I don’t know that we have it broken out here, but I think I can tell you that the European market, and this is fairly good basis and trade association data, is up high-single digits and it’s a combination of Western Europe somewhat less, Eastern Europe somewhat more. But the market is still very strong in Europe.
Not as strong, from a growth perspective as it was last year, but we’re sighting high-single digits and we think the year is going to finish high-single digits for Europe, as a whole.
Mark Wilde - Deutsche Bank Securities
Is it possible going forward that you might be able to give us some more kind of regional break outs to really understand sort of Middle East versus Europe versus Asia?
John W. Conway
Well, we’ll take a look at it. We end up with an awful lot of data and puts and takes and all the rest and sometimes by country it’s not even terribly meaningful, but we would be happy to take a look at it.
Alan W. Rutherford
We report that the way that we manage the business and this is how we manage the business in Europe, it’s European beverage and it includes Middle East and that’s how we report it.
Mark Wilde - Deutsche Bank Securities
It just seems like the Middle Eastern business is growing so much for you. Are freight costs an issue and how do you pass those through, Alan?
John W. Conway
Why don’t I take that, if you don’t mind? Freight costs vary by product category and by country.
By that I mean whose responsibility freight costs are. In some cases we have exports pricing and in some cases we have delivered and in all of our contracts and all of our proposals, where it’s delivered pricing, we attempt to, and we make proposals and we’re largely successful in getting prices that reflect anticipated freight changes.
Now, in the current environment, diesel for example has gotten everyone’s attention, where diesel has gone up so sharply. We’re taking a look at whether we might need to change some of the ways that we price products in 2009.
That is to say we are considering, but we don’t know what we’re going to do. We’re considering perhaps treating the diesel component of freight much as we treat aluminum and steel, which is say, pass it through as it occurs or something like that.
Now, this year we’ve been okay with diesel. Diesel is up but we’ve been able to deal with it.
You can see it in the margins, obviously. But as we look ahead we’re reflecting on how we might go about improving that.
Operator
Your next question comes from George Staphos - Banc of America.
George Staphos - Banc of America Securities
Let’s get back to steel for a minute and obviously there are a lot of questions on it. Isn’t the real issue here just clarity?
If your suppliers want to raise pricing 10% then they just let you know as soon as possible and that number is the number, or if it’s 50% they let you know as soon as possible and that number is the number. And then the suppliers at packaging can get out and do what they need to do.
Would you agree or disagree or offer some comments on that?
John W. Conway
There’s one obvious thing, once you know what it is you know what you’ve got to do but knowing what you have to do and doing it are two different things. We think, and you can see it in our numbers and you’ve been able to see it over the past couple of years, we think we have been highly effective, very disciplined in passing through raw material price increases, wherever it is in the world.
And we have taken the view that we have to maintain and improve margins, we’ve got to improve the returns on invested capital, we’ve got to be able to justify the capital that we’re investing. So execution is key here.
And you look around here and you look around over the next several weeks and you’re going to see, execution is not so easy, George. It’s not simply knowing what it is, it’s then getting it done.
So, yes, the sooner we know, the sooner we can get working on getting it done, but believe me, getting it done is not a small issue. We’re going to get it done and we will see how everybody else does.
George Staphos - Banc of America Securities
I’m not trying to minimize it on your side, but will the terms of pricing simply change, from your understanding, in other words, whatever the price increase will be, that will be the increase for the year or could that change in 2009 or in the future?
John W. Conway
It’s going to depend upon, in the case of steel, it’s going to depend upon how the steel industry chooses to price and we’re hopeful that there will be one price increase for the year. But the steel companies have their own views on that.
Some of them want two or more, some of them want quarterly, and so that debate is still ongoing.
George Staphos - Banc of America Securities
When we look at the bridge in revenues, and I realize that are some things you might not necessarily want to get into, would it be fair to say that volume in total across all your product lines was up something around 3%?
John W. Conway
In the quarter?
George Staphos - Banc of America Securities
Yes. If that’s too hard to get to, we can do it offline.
John W. Conway
It’s awfully hard because we always throw bottle caps in here. So, yes, call us later.
Alan W. Rutherford
It’s apples and oranges.
George Staphos - Banc of America Securities
We shouldn’t forget the bottle caps. In terms of how you grow next year, you’ve obviously had a terrific, so far, first six months; it looks like this year will be very good, given your guidance and you are to be congratulated for that.
Where do you expect the sources of growth, either from a process strategic or regional standpoint to come in 2009?
John W. Conway
Well, I assume you mean segment income growth and then what flows from that.
George Staphos - Banc of America Securities
Yes.
John W. Conway
Well, we think everything is going to be up. We think, as I said earlier, we think the emerging markets volumes are going to continue to be good, we think the mature markets are going to continue to be stable.
We think the industry structure permits us to pass price costs through effectively. We think that some of our returns we’re still not happy with in some of the businesses.
There is still ground to be made up and things that were lost over the last five years as a consequence of some things that we and others did that were nonsensical. So, our plan, as our said in our comments, is we’re counting on 2009 to be up, across the board and I really think it will be.
George Staphos - Banc of America Securities
Where are you still less happy with returns and where you hope to focus on a going-forward basis, and then more shorter term, your year-on-year margin comparisons that have been brought up in the Q&A earlier and European beverage have been very, very strong. Is there a reason to expect why you can’t keep that margin variance over the balance of the year in European beverage cans?
John W. Conway
Well, as to beverage, no, there’s no reason to expect that we’re not going to maintain margins. I think demand is really quite strong and we should be fine there.
As for the product lines, they could all do better, George. They really can, but some of the ones that should be better are pretty obvious to us.
North American beverage should do better. We think it can.
And food around the world can do better and aerosols around the world. And you can expect that.
And we’ve been improving them, we’ve said we’re going to improve them, and so we think they call can improve and will improve.
Operator
That was our last question.
Alan W. Rutherford
Thank you. Well that concludes Crown’s second quarter conference call and we thank you for your interest in our company.
Operator
This concludes today’s conference call. You may now disconnect.