Jul 16, 2009
Executives
Timothy J. Donahue – Chief Financial Officer and Executive Vice President John W.
Conway – Chairman of the Board, President and Chief Executive Officer
Analysts
Joseph Naya - UBS Claudia Hueston - J.P. Morgan Timothy Thein - Citigroup Alton Stump - Longbow Research Christopher Manuel - Keybanc Capital Markets Peter Ruschmeier – Barclays Capital George Staphos – Banc of America-Merrill Lynch Richard Skidmore – Goldman, Sachs & Co.
Chip Dillon – Credit Suisse Albert Kabili – Macquarie Research Unidentified Analyst - Baird Wayne Cooperman - Cobalt Capital Andrew Fineman - Iridium Asset Management Unidentified Analyst - Nomura Securities
Operator
Good morning and welcome to the Crown Holdings second quarter 2009 earnings conference call. (Operator Instructions) I would now like to turn the call over to Timothy Donahue, Executive Vice President and Chief Financial Officer.
Mr. Donahue, you may begin.
Timothy J. Donahue
Thank you, [Shirley], and good morning to everybody. Welcome to Crown Holdings second quarter 2009 conference call.
With me on the call today is Jon Conway, our Chairman and Chief Executive Officer. Before we begin I would like to point out that on this call, as in yesterday evening's earnings 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 the press release and in our SEC filings, including comments in the section titled "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Form 10-K for 2008 and in subsequent filings.
I'll first review the quarter and then hand the call over to John for his comments. Earnings per diluted share were $0.65 in the quarter compared to $0.61 in the second quarter of 2008, an increase of 7%.
On a comparable basis, diluted earnings per share increased 8% to $0.66 over the $0.61 in last year's second quarter. As was the case in the first quarter, all operations continue to perform well, offsetting higher pension expense and currency translation.
And as noted in last night's earnings release, when adjusted for currency and pension, segment income performance in the second quarter was up 18% over the prior year. We continue to be very pleased with our operating performance through the first six months.
Despite the impact of a stronger U.S. dollar and increased pension expense, we nonetheless continue to expand and grow our emerging markets businesses, improve segment income, improve earnings per share and improve cash flow.
John may speak more to this, but we feel very fortunate to understand well the business and markets we operate in. Currency translation continued to have an impact throughout the financial statements; however, underlying performance was again quite good, so as in the first quarter we'll do our best to help you with comparisons excluding the impact of currency.
Net sales in the quarter excluding currency were up 3% over the second quarter of 2008. Beverage can volume growth and the pass-through of higher tinplate costs offset the pass-through of lower aluminum costs and lower food can volumes.
Global beverage can volumes were up 2% in the quarter, which is on the back of 3% volume growth in the 2008 second quarter. Demand remained firm in the Americas, while our developing markets businesses continued to see growth.
Food can volumes remain down from the prior year due principally to continued destocking. We do expect unit volume shipments to improve sequentially as we enter the seasonally strongest food can period in the third quarter.
Adjusted for currency, Americas Beverage revenues were lower than the prior year by 2.5%, which was due to the pass-through of lower aluminum costs. Volumes for the division were level to the prior year and in the United States were up 30 basis points compared to the second quarter of 2008.
This compares to a 90 basis point industry decline. Segment income when adjusted for currency improved by 4% over 2008.
Margins continue to benefit from improved manufacturing performance and an increase in shipments of specialty can sizes. Revenues in our North American Food business increased 14% ex currency year-on-year as the pass-through of higher tinplate prices offset softer volumes, the result of continued destocking.
Segment income improved $9 million due to further improvements to plant manufacturing performance, cost reduction programs and a lower Canadian cost base, which is the result of a 2008 plate plant closure and the weak Canadian dollar. On a currency comparable basis, European Beverage sales were up 8% over the 2008 second quarter due to higher shipments.
The improvement in segment income reflects the benefits of additional volume and better manufacturing performance. Food Europe revenues declined by 1%, excluding currency, reflecting softer volumes in the quarter, the result of continued destocking and somewhat lower demand in some markets which offset the pass-through of higher tinplate costs.
Segment income was up over the prior year, the result of improved manufacturing performance, cost reductions, price recovery and product mix. Excluding foreign exchange, Specialty Packaging revenues were up 4% to the prior year while segment income was down $1 million on lower volumes.
Interest expense was $17 million lower in the quarter and $33 million lower year-to-date as we continue to benefit from lower rates, lower net debt and foreign exchange. As we noted in the release, the company issued $400 million of 7-5/8% senior unsecured notes during the quarter at an all-in yield of 8-1/8%.
We have temporarily applied the proceeds to the company's revolving credit facility, which is now fully undrawn at June 30, 2009. Given that the yield on the new bond is higher than our bank borrowings, we incurred incremental interest expense in the second quarter and expect to do so for the full year 2009.
Our net debt at the end of March was $3 billion, which is $459 million lower than the June 30, 2008 amount and about $100 million lower than at March 31, 2009 before $30 million of currency translation. We continue to reduce our net leverage and based on the past 12 months' EBITDA it stood at 3 times compared to 3.7 times at the end of June '08.
We still project segment income to increase approximately 3% over 2008 and we now expect free cash flow to be at least $425 million after capital expenditures of $160 million. The majority of free cash will be used to continue to reduce leverage.
With that, I'll turn the call over to John.
John W. Conway
Thank you, Tim, and good morning. As Tim has briefed you, Crown had another very successful and strong quarter.
Demand was quite robust for all of our products given current economic circumstances. Our plants ran exceptionally well, price realization continues to be good relative to cost, and we are beginning to see demand improving and believe that the third and fourth quarters should be quite strong.
The new capacity which we have been adding around the world is making a significant positive contribution and continues to validate our strategy of putting significant focus on emerging market opportunities. As you know, we are well-situated in virtually every strong emerging market in the world and believe that we have and will continue to be able to take advantage of exceptional growth opportunities.
In particular, our new capacity in Vietnam is running well. Our new plant in Cambodia is having a very good year in beverage cans.
And as you have probably seen, we recently completed the purchase of a brand-new beverage can plant in Southern Vietnam. We will have it in operation this year and it will make a significant contribution to sales and earnings in 2010.
Our other major capacity additions include our new plant in Northeastern Brazil, which is making a contribution well beyond our initial expectations when we began the investment about a year and a half ago and the capacity which we have added in Spain, which is also performing well. Our new beverage can plant in Slovakia and Eastern Europe will begin production first quarter 2010 and provide a substantial boost to our asset base in the region.
As Tim mentioned, our outlook for the year is still very positive. We fully expect to deliver on our commitment for segment income and we have increased our projection for free cash.
We have a strong organization of outstanding men and women around the world, with top-flight management and we know that we are uniquely positioned to continue to prosper and grow in years ahead. In sum, we had a very strong quarter and anticipate another strong year.
With that, Shirley, we'll open the call up for questions.
Operator
(Operator Instructions) Your first question comes from Joseph Naya - UBS.
Joseph Naya - UBS
Your volumes over the past year or so have benefited from some improvements in private label market share. I know there's been some concern that we could see a little bit of a reversal there if we see increased promotion from some of the branded [soft drinks].
I was just curious maybe how concerned you are about that and how you're positioning the portfolio going forward?
John W. Conway
Really, we're not concerned at all. It is true private label's been a little stronger in the first six months this year than it was last year, but we don't anticipate that that's going to change over the foreseeable future.
And then the other thing to remember is we've got a very strong branded soft drinks business now as well. There's been a rotation in terms of the customers that we're now currently focused on, but the customers we're focused on are doing very, very well, the branded customers, in North America.
So we're calm and cool and collected about that subject and we think we're going to do fine.
Operator
Your next question comes from Claudia Hueston - J.P. Morgan.
Claudia Hueston - J.P. Morgan
I was hoping you could provide just a little bit more color on beverage can volume trends in Europe and what you say maybe by region within Europe?
John W. Conway
Well, certainly we saw an improvement in Western Europe in the second quarter compared to the first quarter. In fact, where we and the industry were down in Western Europe in the first quarter, both were up in the second quarter.
I think our Western European volumes were up about just over 1% in the quarter. We don't have, as you know, any current weighting to Eastern Europe or Russia, so we're not impacted by the softness in that market, but in terms of Western Europe we're doing quite well.
And in the Middle East, as you know, that market has been growing tremendously over the last four to five years, on the order of 20% per year. Growth was much slower in the second quarter this year, still growing somewhat but albeit at lower rates, kind of plateauing and taking a breather for the time being.
Claudia Hueston - J.P. Morgan
And then, if I heard right, it sounds like CapEx is going to be a little higher and it was actually lower than I thought in the quarter, if you just could provide some color on that.
Timothy J. Donahue
Well, I think we previously had told you $150 million. We're now saying $160 million.
Whether or not it was lower or higher to expectations, it's $75 million for the first six months and that's roughly half of $150 million or $160 million. So I don't think there's any indication there that it's being spent quicker or slower.
Claudia Hueston - J.P. Morgan
And the incremental $10 million is, in terms of the guidance?
Timothy J. Donahue
Yes, it's a guidance number at this point based on where we may see opportunities in the future that perhaps we're not willing to discuss yet.
Operator
Your next question comes from Timothy Thein - Citigroup.
Timothy Thein - Citigroup
Just a question on the food can business in Europe. I take it, Tim, were volumes down double digits in the quarter?
Timothy J. Donahue
Well, depending on the market you're talking about there were some markets which are down high single digits. As we previously talked to you in the first quarter - and John was very good in describing I think in the first quarter the issue of trade credit that some of our customers are experiencing with respect to Sub-Saharan Africa and/or Russia - so in the markets where the businesses - where we produce product to serve those markets, some of those businesses were down high single digits.
Timothy Thein - Citigroup
And you guys have done a good job in terms of managing the price-cost spread there and in your aerosols business. First, what are you seeing in terms of spot tinplate prices?
I know you're not active there, but others are. And if in fact you do see some downward pressure in the spot market in the back half of the year, are you confident that you'll still be able to manage that price-cost spread for the balance of the year?
John W. Conway
Yes, we are. And we've got, I think, somewhat better visibility with regard to steel tinplate prices now.
And I think generally speaking around the world we will be seeing downward price adjustments this month, in July. And we do have plans in place to make appropriate reductions with our customers over the course of the next two to three months.
Our policy position and we've told the customers that as we run through existing finished goods and raw material inventory and we're able to give them the benefit of reduced steel prices, we will be doing so. But that's several months away.
We think we're going to be very successful in this. We think we did a very conscientious and careful job as tinplate prices ran up and we're going to do a similar job as they go down.
We don't anticipate margin loss as a consequence. And, as Tim said earlier, we had planned for this and we continue to think that our segment income performance is going to be very, very strong ex pension and currency and it's going to be in line with our projections.
Timothy Thein - Citigroup
And just lastly, do you think there's been much, if any, switching from steel to aluminum in the various markets or not much?
John W. Conway
No, virtually none. A little bit of talk about some fish business perhaps in Europe, but not a lot.
And we have a fairly big aluminum business in fish, also, so we're not being hurt by that.
Operator
Your next question comes from Alton Stump - Longbow Research.
Alton Stump - Longbow Research
Just to sort of get back to food can volumes in Europe, if I'm doing my math right I get to about a high single digit volume decline overall in 2Q, very similar to what we saw in the first quarter. Is that accurate?
Timothy J. Donahue
Yes, that's pretty close.
Alton Stump - Longbow Research
Okay. And then was there any of that that was due to customers waiting ahead of this price decrease that you mentioned coming in July?
John W. Conway
It's possible, but if it's true we think that logjam is going to break because can prices, particularly for the seasonal packs in Europe, will not be going down until on the order of October 1 in Europe. At least that's our plan, and we think we can make that stick.
You know, we build inventory for the seasonal packs - we have to - and we are not going to be reducing prices until we've sold through the higher-priced input.
Alton Stump - Longbow Research
And then just one last quick follow up. In terms of the destocking going on, does it appear that that has stabilized?
I think you mentioned, Tim, that you do expect some improvement sequentially with that issue. I just want to get some color as to how much of an impact that may or may not be in the third quarter.
John W. Conway
We think it has stabilized. We think we're going to see now rebuilding in the third quarter.
Frankly, we were a little surprised that it carried on as long as it did, although, as we read the financial press and you do the same, we realize this destocking phenomenon is not limited to the food industry; it's very, very pervasive. It did carry on longer than we had thought that it would, but we're now seeing signs - clearly seeing signs - that normal inventories are being rebuilt.
What we're hearing on both sides of the Atlantic in North America and in Europe is that anticipated crop yields are quite high. The sweet corn crops, the pea crops, etc., seem to be doing very, very well, so the expectations are quite a full harvest on both sides of the Atlantic.
So we're anticipating it's going to be a good seasonal pack.
Operator
Your next question comes from Christopher Manuel - Keybanc Capital Markets.
Christopher Manuel - Keybanc Capital Markets
First, just to kind of follow on what Alton's talking about with some of the destocking and things, would it be your anticipation that given what crops we have in the ground as well as other miscellaneous factors that as we work through the full year your food can volumes globally should at least be flat if not potentially up a point or two - in other words, recover that back in the back half of the year.
John W. Conway
Year-on-year?
Christopher Manuel - Keybanc Capital Markets
Yes.
John W. Conway
We're not sure that that's going to happen, Chris, and I'll tell you why. I think that the pre-buy and perhaps even packing in the fourth quarter in retrospect may have been more than we had thought.
And the other is although there is restocking now going on, there's a view that the supply chain downstream from us will not return to the same levels of working capital that they had in the past. So we think it's doubtful that we're going to get back to the same sales unit numbers for the year as we had last year.
Christopher Manuel - Keybanc Capital Markets
And then, Tim, earlier in your prepared comments you indicated that initially you had paid down the bank revolver and it sort of sounded as though you had other plans as the year progresses for the money. Could you help us a little there as to what else would you anticipate doing?
Timothy J. Donahue
Well, I think, as we said in the note offering documents, that we were very clear that we were going to use the proceeds to temporarily repay short-term bank borrowings and that looking forward that we could use the money for a number of alternatives - to increase liquidity, for general corporate purposes, potentially for acquisitions and/or to term out some of the near-term debt that comes due in 2011. So I don't think we've changed the outlook as to what we're going to do with the proceeds of that note offering or the cash that we have begun to generate this year already.
Christopher Manuel - Keybanc Capital Markets
Then the last question I had was it sounds like I think earlier in the year you'd reported to us that you may be delaying a little bit or holding back a little bit on the plant in Slovakia. It sounds like that's back on track.
With that in mind, as you look globally, with the growth you guys have had the last few years in the Middle East and that region and other regions of the world, where do you stand from a utilization standpoint? I'd have to think that there would be a number of regions globally where over the next few years you may need to add capacity.
So I guess the question, John, is how do you think about uses of capital over the next few years or globally, I should say, as well, with opportunities that are available in the marketplace?
John W. Conway
Well, our thoughts haven't changed very much. I mean, as you're suggesting, we're largely sold out in most of our businesses, particularly our beverage businesses.
We've sold out all of our capacity. We're a little light this year in Western Europe still because of the slowness of the market there, but we think that's going to come back.
And in terms of where we see the significant growth opportunities with relatively very good returns continue to be the same as they have been, which is to say China and Southeast Asia, South America, and Brazil and Colombia in particular. And the Middle East and North Africa we believe is still going to continue to grow.
And we think that Eastern European growth's going to come back. We're focused essentially on Euroland and Slovakia, Hungary, Poland, Czech Republic, etc.
We're not thinking of making a dive into Russia, Belarus, Ukraine. So we think that market's going to come back.
So at the moment we're anticipating we continue to push capital in that direction. That's where we're getting the great returns; that's where we getting growth.
And it's been a huge boost and benefit for the company.
Operator
Your next question comes from Peter Ruschmeier – Barclays Capital.
Peter Ruschmeier – Barclays Capital
I had a similar question, I guess, on capacity utilization. I'm curious if you could remind us of some of your new initiatives in the last, say, 18 months - Vietnam, Brazil, Spain, Slovakia can you remind us of the capacity of those?
And you mentioned that beverage is running pretty full out, sold out. I'm curious how tight you feel you are on your can capacity globally in terms of looking at increasing utilization versus growing your units.
John W. Conway
Well, the additions have been relatively significant in 18 months. But if you go back over, say, three years, when you roll up - and I'm kind of pulling a number out of the air because I don't think we have this specifically - but if you remember the significant additions we made in the Middle East, North Africa, a new high-speed line in Spain, a new quite large line, a single line, in the plant in Slovakia coming on, and then in Brazil we built a major new plant in the north we're looking at other opportunities there - and in Southeast Asia significant capacity additions in Vietnam, Cambodia, I'm guessing we're talking something on the order of 5 to 7 billion cans.
But you can call us, Pete, later and ask us. So it's been pretty substantial.
And to kind of repeat what I said, we are literally sold out in every market with the expectation of Western Europe - parts of Western Europe. So, put another way, we see a lot of opportunities.
I mean, the Vietnamese plant that we just built - bought, rather, from a good customer, we know we're going to sell it out immediately. So we're looking at China; we think there are opportunities there.
There are other opportunities in Southeast Asia. So, frankly, as we have had for the last number of years, we've got more good opportunities than we can grab immediately, but, of course, we've got a great pipeline.
Peter Ruschmeier - Barclays Capital
And maybe to better understand your thought process, what was it about the Vietnam acquisition that really appealed to you? Why is it that it fit?
Why is it you pulled the trigger on that opportunity?
John W. Conway
Well, it's another plant in the South; we have a large plant there, so we're going to get some nice synergy savings associated with running it. It's a factory that we purchased.
It was about 90 percent complete. We think we can quickly bring it to completion.
We'll be making cans commercially this year. And we have an arrangement there with a major customer who's going to continue to be an equity owner - but an investor, not a manager; we'll run the business in all respects and that will secure the volume.
Also we know that market very, very well, and we know that we're going to be able to sell capacity out immediately.
Peter Ruschmeier - Barclays Capital
A somewhat random question but, just in light of the potential CIT filing, I'm curious as you think about the distribution channels and some of the smaller players that might be involved, do you anticipate any kind of domino effect from a filing such as that of CIT? And related to that, as you constantly look at your receivables and your counterparty risk of your customers, any noteworthy changes there or do you still feel very comfortable?
Timothy J. Donahue
I would say that I don't think we're prepared or conversant enough to comment on the CIT issue, but I will say that all of our businesses are reviewing receivable balances and the collectibility, not only the ultimate collectibility but the collectibility within the payment terms that are prescribed on the invoice; that's part of the compensation structure and the incentive structure for our managers. So there's nothing that we're aware of right now that would cause us to believe we need to make any provisions.
Operator
Your next question comes from George Staphos – Banc of America-Merrill Lynch.
George Staphos – Banc of America-Merrill Lynch
When we look at the volume progression in the U.S. and North America second quarter versus first quarter, while you did, again, better than the industry, the pace of progress or relative progress decelerated.
My recollection is that's just a comparison issue; I think you picked up some volume in 2008 which you might have lapped. But if you could give us some details around that.
Timothy J. Donahue
Well, I'll let John jump in in a second. I mean, one thing we certainly can say, George, is that we sold far more cans in the second quarter than we did in the first quarter, so it's a relative comparison issue.
And as we described to you, perhaps in the first quarter, one of our larger beer customers, it gained share in the first quarter. But I don't think there's anything - there's no conclusion, if you're trying to draw a conclusion that things aren't going well, that's certainly not the conclusion.
I think that I would say we remain very pleased. Again, we outperformed the industry by about 120 basis points in the second quarter.
Now, I realize we outperformed the industry by about 500 basis points in the first quarter, but that's not us slowing down; we're still accelerating can sales.
John W. Conway
Yes, George, there's no trend here if you're wondering what some of our competitors might be subsequently reporting. There's no trend here at all.
And we think the second half of the year for us in Beverage is going to be very strong. Our plants are running exceedingly well.
As we constantly benchmark our costs against the competition, we think we're perhaps the low-cost or certainly one of the one or two low-cost producers in North America. And so we're very confident about Beverage.
We have absolutely no concerns at all and there's nothing in a relative sense that's happening that should lead you to the conclusion that in the second half of the year Crown will be relatively less well-position in the second half than it was in the first.
George Staphos - Banc of America-Merrill Lynch
Okay. It was more of an observation than a critique, but nonetheless we appreciate the clarity on that.
As we look out into, say, the middle of 2010, how much annualized capacity will you be adding in your emerging markets - well, I shouldn't even say that - your non-North American businesses in beverage cans? If we think about Vietnam and Spain -
Timothy J. Donahue
Why don't we just deal with Slovakia and the new plant in Vietnam? And roughly that will come to about 1.5 billion units.
And I think that's all we're prepared to really talk about at this point. In addition to that, obviously, the new lines in the northeast of Brazil and Spain that we brought on late last year, earlier this year, obviously will produce more cans next year than this year, but new capacity, 1.5 billion.
George Staphos - Banc of America-Merrill Lynch
Now, when I look at your comments regarding being virtually sold out in every beverage can market that you participate in and I look at the returns that you've put up over the last 10-plus years - which, again, you guys should be commended for; depending on which metric we use, you've trebled the numbers - why would you or would you consider any expansion in capacity in North America or acquisitions in North America? It seems like you have virtually untapped potential outside North America and the returns have been terrific.
Can you help us think about that regionally or geographically?
John W. Conway
Well, you know, George, we have been considering capacity expansion in North America and I guess you're referring to the InBev Metal Container opportunity. And we're very confident about our ability to run all factories in the beverage industry and all metal packaging, we think, exceptionally well, and so on.
On the other hand, we have attempted to be a very disciplined, value investor in all respects, including utilization of CapEx and acquisition funds. And we have seen that our emerging markets are growth markets, so every investment tends to get better over time as a consequence of more units under the same roof, etc., and it leads us someplace else.
So when we look at acquisitions that are trading a pile of money today for a rather fixed annuity stream in the future in a market that's flat, we have an interest, of course, because we think we can create value there, but we're being very careful and very self-disciplined about what we're prepared to trade. So if something attractive were to arise, if our circumstances were to change, we'd of course be interested in doing something in North America and maybe that'll happen, but as you can tell from reading the press, it hasn't happened yet.
George Staphos - Banc of America-Merrill Lynch
You did a wonderful job on working capital; you're obviously pretty well-positioned as you head into the back half of the year. And you mentioned that you feel pretty confident that you'll be able to manage whatever happens on tinplate relative to your customers and your markets in the back half of the year.
What would be the risks to that actually happening, though, and would there be any mileposts that you would relate to us that we should keep tabs of as we evaluate your ability to execute on that?
Timothy J. Donahue
On working capital?
George Staphos - Banc of America-Merrill Lynch
Well, really more on managing tinplate relative to your margins relative to the rest of the year.
John W. Conway
Well, George, I guess I mean it would be similar to a question that everybody was asking in the fourth quarter last year about the risk that we would be able to pass-through price increases that we were seeing at the time. And we told you then that we had a high degree of confidence as a consequence of our positions in the food can industry, aerosol industry, the [inaudible] consolidation, our view of our cost structure versus our competitors' cost structures, which is to say everybody roughly equivalent, our view of our raw material cost position versus our competitors, everybody roughly equivalent, our view of our competitors' managements - they're all pretty careful, smart, able, capable people that are trying to maximize returns for their shareholders - all of that led us to conclude that we were going to be able to push the tinplate price increase through as we needed to as we just - to the conclusion that we're going to be able to adjust prices as we need to over the next two to three months.
So we think it's a low-risk proposition.
Operator
Your next question comes from Richard Skidmore – Goldman, Sachs & Co.
Richard Skidmore – Goldman, Sachs & Co.
A question really on free cash flow. As you look at the first half, it's running about $190 million better than the first half of 2008.
And as you look at what your guidance implies for the back half, it sounds like you could replicate at least what you did in the second half of '08 in terms of free cash flow. Is there something that we might be missing in that analysis - so that it looks like if you run at $190 million better and keep that there then you're somewhere in the mid 400s in free cash flow or slightly above that.
Timothy J. Donahue
Okay, we've given you an estimate - in fact, we raised the guidance, Rick, to at least 425 from $400. There's still six months to go in the year and maybe you're right, but that's what the term "at least 425" means.
I think that's all we're willing to project at this point given that there's still a fair amount of time left in the year.
Richard Skidmore - Goldman, Sachs & Co.
And as you look at that bridge and as you look at the segment operating profit of 3% growth year-over-year, the first half was around 1%. Does the growth in EBIT in the back half of the year come primarily from a better food pack, as John alluded to, or is there other things?
Is it just the additional can volume? Can you help just bridge the growth in the second half versus this year versus last year?
Timothy J. Donahue
Yes, I think that if you look at last year one of the big things that will happen in the back half of this year is that when we get to Q4 we're going to have a positive currency comparison. So as we look at the first three quarters of this year, currency is going to be negative.
And you see that at the segment income line it's negative $40 million through six months. It'll be negative again in Q3, but it'll turn positive in Q4.
And so for the back half of the year currency is much flatter than it has been for the first half of the year, the impact of which on segment income. That would be one issue.
And as we said, we do expect food and aerosol can volumes to improve sequentially as we go through the year.
Richard Skidmore - Goldman, Sachs & Co.
And then, Tim, just lastly you talked about using the free cash flow primarily for debt reduction. Given both the stability of your free cash flow, the magnitude of the free cash flow, and your leverage ratios, any thoughts to revisiting share repurchase at this point?
Timothy J. Donahue
I think at this time, as we've stated previously, we have obviously taken advantage of the capital markets and we were very pleased with the capital markets' reception to our note offering in early May, so that is the beginning of terming out some of the debt that comes due in 2011 and 2012. But I think we're going to remain cautious on share buybacks until we get a little bit greater clarity on the health of the global financial institutions.
So I think for this year I don't think we're going to revisit buying shares.
Operator
Your next question comes from Chip Dillon – Credit Suisse.
Chip Dillon – Credit Suisse
My first question is you did increase your free cash flow guidance by about $25 million while the CapEx is going down. Could you just briefly tell us what is contributing to the increase despite the higher CapEx?
Timothy J. Donahue
I think that implied in that is $35 million more of operating cash flow, I guess is where you're trying to go, and what's the reason for that. The big reason is that we can now see sequential or better improvement in food and aerosol can volumes for the balance of the year.
And as you will always hear us tell you, as we get further along in the year we get a little bit more comfortable with where we think the year is going to turn out. Having said that, there's still six months to go in the year.
Chip Dillon - Credit Suisse
And then, secondly, you mentioned the currency turning positive in the fourth quarter and the impact in the second was a little bit more than we thought; it was certainly more than the first quarter, as you pointed out. How do you see the third quarter as you transition to a positive impact in the fourth quarter?
Obviously, you expect it to be - and where rates are now it would be less - but would it be like halfway between what we saw in the second quarter and breakeven or how do you gauge that?
Timothy J. Donahue
I think that in the third quarter you should expect a number, again, similar to the second quarter. If you go back and look at where the dollar was against the sterling, against the Canadian and specifically against the euro through the second and third quarters last year, you'll see that the dollar was quite weak and it did not begin to gain strength until the fourth quarter.
In fact, I think the dollar hit its lows in the mid-150s and perhaps even touched close to 160 some time during the third quarter last year, before things started unwinding in mid to late September, early October. So Q3 will be another number where the impact on segment income is unfavorable and then it will turn favorable based on where we see rates today in the fourth quarter.
Chip Dillon - Credit Suisse
And then the last question is I recall from the first quarter call how the momentum seemed that you talked about over the last few years in the Middle East seemed to be somewhat attacked. Were you surprised at sort of the plateauing at a lower level that you saw in the Middle Eastern bev can business in terms of growth rates?
Is this sort of a pause? Not that you would expect to maintain breakneck growth, but do you think that it will be higher in future quarters year-over-year than it was in the second?
John W. Conway
Yes, we think so. I mean, the pause - and I really think that's what it was - is primarily related to the Jordan and Iraq markets; Saudi and the Gulf are still very strong.
And so we think the trajectory throughout the region is going to continue to be positive. But as Tim said, the 15% to 20% growth we've been seeing for the last number of years we think is going to be difficult to sustain going ahead, if for no other reason that there is some, as you know, financial restructuring associated with a little bit of excessive credit in the Gulf.
And that's inevitably going to have an effect on demand.
Chip Dillon - Credit Suisse
And, John, I have to ask you this. It's interesting you mention how the acquisitions - and you mentioned Vietnam as one being recent - overseas tend to have an added plus versus what you could do here because the volume under the roof goes up year to year.
Given that effectively most of the third-party assets of InBev have actually gone to another major player, is there less reason for you to be involved in the rest of the assets there?
John W. Conway
Well, you could make that argument and we've had that discussion. We think what has been left with InBev is essentially a beer can self-manufacturing operation.
And InBev's participation in the soft drink can market in North America is quite small now, not insignificant but quite small. And then when you look at where they're participating, they're in regions of the country where we're simply not present - California and Florida, for example.
So it slows you down a little bit in terms of wondering what you're going to accomplish with an acquisition in a no-growth market. Having said that, we run beverage plants very successfully; we understand that we could.
But it's influenced our thinking, what you described.
Operator
Your next question comes from Albert Kabili – Macquarie Research.
Albert Kabili – Macquarie Research
I guess circling back to food a little bit, I guess the tinplate and it looks like there's going to be a bit of a delay in reduced pricing over the next couple of months, does that suggest in the third quarter that food can volumes are again at risk of kind of sluggish end market demand as customers order the very bare minimum until they expect the lower prices two or three months down the road? I just wanted to get some help on your thoughts on that.
John W. Conway
We really don't think so because the nature of a seasonal pack - I mean, just think of the crops, tomatoes, sweet corn, peas, light fruit, etc. - you cannot delay packing.
So we do not think that's the case; the customers are not signaling us that and we have no reason to believe that's going to occur. I mean, there's always a risk of it, but we think it's as a practical matter virtually impossible.
Albert Kabili - Macquarie Research
And to your point, I would imagine that your customers would have had to have put in a lot of the orders already to make sure they've got the cans for the pack, and just wanted to get thoughts on any visibility you have in terms of year-over-year order trends and how that's shaping up.
John W. Conway
Well, I mean, generally speaking quite good. And what the customers' communications are reflecting is what I said earlier, which is crop yields that look very favorable in North America and in Europe, and including Spain and Italy as well.
Albert Kabili - Macquarie Research
And so by good is it up year-over-year in terms of this kind of ordering pattern thus far?
John W. Conway
Yes. Crop yields are up and indications from customers are quite strong.
Albert Kabili - Macquarie Research
And that's both Europe and the U.S.?
John W. Conway
Yes, it is.
Albert Kabili - Macquarie Research
And then I may have missed it in North America Food, what the currency impact was during the quarter and what the underlying volumes were.
Timothy J. Donahue
I think underlying volumes we said were down mid single digits. There's very little currency impact.
There's a little bit of the business in Canada, but very little currency impact.
Albert Kabili - Macquarie Research
And then if we could just switch to bev cans, could you give us some color on the relative performance of beer versus carbonated soft drinks in the U.S. as well as Europe?
Timothy J. Donahue
We don't have industry information yet for Europe. I do know that based on the industry information we received in North America it looks like beer was up about 2.5% in the quarter and non-alcoholics were down about 2.5% in the quarter.
Albert Kabili - Macquarie Research
And then lastly, Tim, on pension, it looks like you were up $25 million year-over-year on pension expense for the quarter and I thought you guys were running close to kind of up $30 million plus.
Timothy J. Donahue
Yes. I saw your note this morning.
Pension expense for us in both Q1 and Q2 was $32 million each, so it's $64 million for the year. The spread to last year's second quarter is lower than the first only because in the second quarter last year we had higher pension expense than we had in the first quarter of '08.
So if you go back to our 10-Qs last year you would see that Q2 '08 pension expense was higher than Q1 '08 pension expense. Nothing's changed on the trajectory or the initial guidance we gave you with respect to how much pension expense would be up year-over-year.
Albert Kabili - Macquarie Research
So we should still be expecting about $120 million for the year?
Timothy J. Donahue
Incremental?
Albert Kabili - Macquarie Research
Year-over-year.
Timothy J. Donahue
Incremental, that's right.
Albert Kabili - Macquarie Research
Incremental expense?
Timothy J. Donahue
Yes.
Operator
Your next question comes from Unidentified Analyst - Baird.
Unidentified Analyst - Baird
John, given the fact that we're almost a year into this global downturn, which obviously it really hasn't affected your business, but can you comment on how your customers are adjusting to the current environment? You know, clearly consumers are trading down in the U.S.
and I think there's some indication in Europe as well, and it seems to be impacting both the beverage and food category. Are you getting the sense that the branded guys are out there starting to aggressively think about defending share here and is that going to be enough of a category mover for you going forward?
John W. Conway
Well, we do and I think it's going to be positive for everyone, the entire can industry. And we're beginning to see signs that certain of the major branded customers are becoming more aggressive with promotions and so forth.
We have a pretty good mix of business, so we think that's going to be positive. And of course I think and Tim mentioned the soft drink/beer numbers.
I mean, some of that, of course, we all know is beer customers trading down and the brewers themselves changing pack mix. So it all looks pretty positive to us.
Unidentified Analyst - Baird
And if you were to compare Europe and the U.S., is there any big change in terms of promotional activity at the customer level, etc.?
John W. Conway
You know, we haven't seen it as much in Europe, but both our private label and branded products customers are doing quite well in Europe in a relative sense.
Unidentified Analyst - Baird
And then, Tim, clearly FX and pension, if you just assume the first half run rate, is almost $200 million of EBIT year-over-year. FX, I guess, is a little bit easier to model, but in terms of pension, if the equity markets and the discount rates hold here, what kind of impact would you estimate that it would have on next year from a variance perspective?
Timothy J. Donahue
Well, if the overall equity markets perform as well as Crown stock has this year, we'd be in great shape. I had to get that in - I'm sorry.
Listen, the S&P is up a little over 3% year-to-date and if we can continue to get some momentum there I think that that will help. The other thing that's going to help is it does appear that the discount rate's going to be higher at the end of this year than it was at the end of last year.
Now having said that, as you know, we don't smooth pension expense, so we don't look for any further downside next year in pension whereas some of the guys that are smoothing have another downside to come whether the markets go up or not. But it's a little early to project where we're going to be on pension next year only because we don’t know what the equity markets are going to do.
At this time last year I don't think any of us would have foreseen what happened in late September of the fourth quarter last year in the market. So I think we know where we're at, but to try to model it forward, I don't think we believe that the number is going to be larger negative next year.
I think we probably believe that we'll reduce the expense next year, but we really have to wait and see where the markets go.
Operator
Your next question comes from Wayne Cooperman - Cobalt Capital.
Wayne Cooperman - Cobalt Capital
On the cost side, what's happening if you take out all the currency on your cost-per-unit basis? How much if any benefit are you seeing from lower energy costs and other manufacturing costs?
John W. Conway
The energy costs are a relatively small proportion of cost of goods sold for us, under 5%, something in the neighborhood of 4%. So we're seeing a little benefit, but not a lot.
A little bit of benefit from freight cost reductions as well. And, of course, as you know, generally speaking aluminum costs have been down, but we passed those through.
Wayne Cooperman - Cobalt Capital
Right, ex aluminum.
John W. Conway
Oh, ex aluminum, ex steel, we're seeing a little bit of improvement in some energy costs, but not a great deal.
Wayne Cooperman - Cobalt Capital
Well, could you tell us what your cost per unit is if you back out - I'm just curious if you're making cans for less money or more money or the same?
Timothy J. Donahue
Wayne, I think we understand or we appreciate why you're interested in that. We don't think it'd be helpful to really discuss that.
Wayne Cooperman - Cobalt Capital
Well, I guess if we got a little price increase next year, would we expect margins to go up? It's just so hard to tell with the aluminum pass-through and the currency, I'm just wondering on a kind of adjusted per-unit basis if we would expect profitability per unit to go up next year?
John W. Conway
Well, it's a little early to say. We've been pointing out for a number of years - and I'm sure some of our competitors have as well - we have a very consolidated industry.
Demand is firm in the mature markets, growing in the emerging markets. And as we run our plants better, load them more fully, incrementally add capacity, we believe if we're careful about price we can improve margins and profits.
We've done that the last number of years; we intend to continue to do it.
Wayne Cooperman - Cobalt Capital
Obviously, I own the stock, but the valuation relative to the free cash flow you guys are generating is kind of silly. Probably somebody asked this before, but at what point do you stop paying off relatively cheap debt and buyback really cheap stock and keep the leverage flat to increase it?
Timothy J. Donahue
Listen, I think we understand that valuation question and we understand perhaps your frustration as a shareowner.
Wayne Cooperman - Cobalt Capital
I'm not really frustrated, just curious.
Timothy J. Donahue
I think that, as we said earlier, until we get some greater confidence the global financial institutions are really healthy and that there's more than three financial institutions that are healthy we're going to be very cautious about how much leverage we run coming into the refinancing that's due in 2011.
Wayne Cooperman - Cobalt Capital
Right. I mean, at some point or other you're just unhelpfully unleveraged.
Timothy J. Donahue
Well, I think one of the advantages we have perhaps against some of our competitors is we still have leverage, so we still have the power of deleveraging to create value and we still see that.
Wayne Cooperman - Cobalt Capital
Right. I agree, although I think if you're paying off 5%, 6%, 7% pre-tax debt, it's not particularly powerful to deleverage.
Timothy J. Donahue
Well, but be careful, though, Wayne, because I think that as we look forward we don't expect and I don't think anybody should expect that refinancing rates are going to be the same as what they were in 2005, 2006 and 2007.
Wayne Cooperman - Cobalt Capital
You guys just raised a lot of debt at 8%.
Timothy J. Donahue
Well, that's more than 6% or 7%. And so every dollar we pay down today is less dollars we need to borrow at a higher rate in the future.
Wayne Cooperman - Cobalt Capital
Understood. But even 8% after tax is still a relatively low return and I think as you generate more cash your borrowing costs probably are going to come back down as the world normalizes.
But anyway, I think you guys are doing a great job. Congratulations.
Thanks.
Timothy J. Donahue
Thanks, Wayne.
Operator
Your next question comes from Andrew Fineman - Iridium Asset Management.
Andrew Fineman - Iridium Asset Management
I just first of all want to say that I commend you for your comment on a pile of money for a fixed amount of volume in North America. I think that InBev probably needs you more than you need them and over time they'll probably realize that.
But if they don't and you have all this money, do you think that you'll be in a position to get your ratings improved to investment grade and as a result have a permanent reduction in your borrowing costs going forward?
Timothy J. Donahue
Well, as you look at the - and I know, Andy, you're very familiar with - our capital structure, we have, not a very complex capital structure, but it's a little bit more complex than many, so there are various tiers. And we do believe that over the next two years if we're very disciplined that at the senior secured level of the capital structure that we can get that to investment grade.
In fact, one of the agencies has that tier of the capital structure already rated investment grade and the other is just one notch below. The debt that we're looking to refinance in 2011 and 2012 is senior secured debt, so to the extent we get the ratings for that tier to investment grade from both agencies I think your point is well taken.
Operator
Your next question comes from Unidentified Analyst - Nomura Securities.
Unidentified Analyst - Nomura Securities
Just one thing, it's on the European Food business. I was just wondering, we have heard of a lot of tinplate cost increases and other cost increases, but my question essentially is that your segment margins basically have shown quite a bit of an improvement on a lower sales base, so could you just lead me through what kind of benefits you're seeing on the cost side which has led to this higher margin?
Timothy J. Donahue
Well, I think the first is that each year we do get better in our factories from the standpoint of efficiency and productivity. And if one has a proper price policy or you're very disciplined with respect to price, the first thing you do is you keep the benefits of your improved manufacturing performance and productivity.
And then number two, we have a responsibility to earn acceptable returns in our business given all the risks that we face, so we are pricing the product accordingly with respect to the increased risk we're taking on this year with the increased price of tinplate.
Unidentified Analyst - Nomura Securities
So if I just carry on from there, if you look at the European harvest season globally, it started coming up at the end of June, if I'm not mistaken. Do you think you're talking about a decline, a higher single digit volume decline in the European Food business, but going forward into the third quarter when probably more of the stronger seasonal part comes up are we going to see kind of a positive change on volume trend?
Timothy J. Donahue
Well, we may see that in some of the markets and then in some of the markets, as we described earlier, where international trade credit is a function of the selling part or the collectibility of cans sold into those markets, we may not see positive returns. But we do expect improvements in all areas in our European Food business.
Operator
At this time I'll turn the call back over to the speakers for closing remarks.
Timothy J. Donahue
Okay, we have no more questions. Very good.
Well, Shirley, thank you very much and that will conclude our call today. And we thank all of you for joining us and we'll look forward to speaking with you again in October after the conclusion of the third quarter.
Thank you. Bye, now.
Operator
Thank you. And this does conclude today's conference.
We thank you for your participation. At this time you may disconnect your line.