O-I Glass, Inc. (OI) Q1 2008 Earnings Report, Transcript and Summary

Good morning. My name is Natasha, and I will be your conference operator today. At this time, I would like to welcome everyone to the O-I First Quarter Earnings Release Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. [Operator Instructions]. Thank you. I would now like to turn the conference call over to our host, Mr. Ed White, Chief Financial Officer. Sir, you may now begin your conference.

Thank you, Natasha, and good morning from Perrysburg, Ohio. We are here today to discuss our first quarter 2008 results and answer any questions you may have. With us on the call this morning is our Chairman and CEO, Al Stroucken, and our Vice President of Investor Relations, Paul Butts. Several other members of the senior management team are here as well. Before I turn the call over to Paul to review the company's position on forward-looking statements, I want to remind you that we will be hosting an Investor Conference in New York on May 13th. That conference will also be webcast and we will announce details soon. At that conference, we will provide an in-depth perspective on the direction of the company. While our comments on the call today will address the progress we've made over the last year and focus of course on the first quarter of 2008, we will save the more strategic discussions for New York. The format of today's call is consistent with past calls. After Paul covers some preliminary matters, I will summarize the quarter's financial results and Al will offer some perspective on the quarter and our performance in different regions around the world. Afterward, we will be glad to take your questions. Paul?

Thanks, Ed. We would like remind you that in discussing the company's performance today, members of management may make forward-looking statements within the meaning of Section 21E of Securities and Exchange Act of 1934 and Section 27A of the Securities Act of 1933. Such statements relate to future events and expectations and 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 risk factors that could affect 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 this call. Also during the call, members of management may refer to certain non-GAAP financial measures. Information regarding those non-GAAP financial measures as well as a reconciliation of the non-GAAP to GAAP financial measures is available on the OI website. Yesterday after the market closed the company released its first quarter results. The earnings release stated that additional information will be posted on our website. Ed will refer to those charts this morning to help illustrate and reconcile results with prior year. If you've not already accessed these charts, you can go to our website at www.o-i.com and click on Investor Relations and look for the charts under the events in Presentations section. The chart numbers are in the lower right-hand corner. Ed?

Thanks, Paul. I am proud and pleased to report that 2008 has started out as a very good year for OI. We are continuing the positive trend we experienced in each quarter of 2007. Results for the first quarter of 2008 showed improvement by nearly every measure over the prior year quarter. The strategies we began implementing some 18 months ago continue to bear fruit. The 2008 first quarter EPS is the highest first quarter since we became a public company after the 1991 IPO. In fact, it is the highest of any quarter since 1991. And for the first time since 2002, cash provided from continuing operations in the first quarter was positive. So in some respect, we are in uncharted territory as we discuss key drivers of our business and the potential impact they'll have over the course of 2008. I will talk a bit more about this at the end of my remarks. Before I begin to review of the website charts, let me point out some changes we've made in the way our financial information is presented in the earnings release. You'll notice that our income statement now presents gross profit, which is one of our key management metrics. Because this presentation is more in line with the other way that companies report, it should make it easier for you to make comparisons. You will also see some changes in our segment-reporting table, which is the last table in the earnings release. We're now reporting our sales and operating profit by region on a quarterly basis. Previously, we had done so only on an annual basis. And as an aid to you, we’ve broken out our 2007 results on a quarterly basis by region in website chart number seven. So now let's turn to the website charts. On chart number one, we've shared some highlights since our last earnings call. I want to expand on just a couple of them. First is our credit rating. The family credit rating for OI debt has been upgraded to BB by Standard & Poor’s and to Ba3 by Moody's. We see this as an independent confirmation of the progress we have made to strengthen our balance sheet, improve liquidity and significantly increase free cash flow. We’ve something else to celebrate this quarter, the official opening of our newest glass container operation in the outskirts of Lima, Peru. We were honored to have the President of Peru and other senior government officials participate in our opening ceremonies. At the same time, we announced our plans to establish a fourth global engineering center in Peru, which will give us an engineering group in each of our region. All of these centers work as a global virtual team. Moving to chart number two, you see the first step on our EPS reconciliation between US GAAP and non-GAAP earnings for the quarter. The first quarter net earnings result amounted to $1.04 per share on a GAAP basis with $1.02 from continuing operations. Excluding the first quarter charges for restructuring and asset impairment, EPS was $1.08. By any EPS measure, we exceeded the prior-year first quarter by more than a factor of three. Further, this quarter's improvement included the effect of a larger denominator. We had $13.5 million more common shares on a fully diluted basis. This was about a 9% increase in share account over the first quarter of 2007. The increase included the effect of converting $9 million preferred shares into common shares along with the dilutive effects of stock options and other equity grants over the last four quarters. And when we first announced our global footprint review in mid 2007, we estimated that it would result in restructuring charges over seven or eight quarters and that it'd be in the range of $150 million. Charges in the first quarter of 2008 amounted to $12.9 million or $9.7 million after tax. We have recorded pre-tax charges of about $113 million in total over the past three quarters. Now, let's move to chart number three for the second step in our EPS reconciliation and look at the drivers of the significant year-over-year increase in first quarter EPS from continuing operations and after excluding the Note 1 item. Earnings per share were $1.08, $0.77 above the first quarter 2007 EPS of $0.31. As I pointed out earlier, this was a record result. As expected, the very strong performance from price and product mix was the key driver in the quarter, contributing $0.48 to the increase. Offsetting the impact was lower sales volume, which took back only $0.05. I will discuss this further when we move to the sales reconciliation chart. Manufacturing and delivery costs took a $0.23 penalty against prior year, with much higher inflation outweighing our continuous improvement on the productivity front. We will also discuss inflation further when we move to the reconciliation detail for operating profit. The continuing decline in the US dollar against foreign currencies resulted in a translation benefit of $0.14. Retained corporate cost and other improved by $0.12. The reason for this improvement was split about evenly between our new corporate cost allocation method and some one-time benefits that were specific to the first quarter comparison, which I will detail in a moment. Not unexpected was the $0.09 improvement in EPS from lower interest expense, principally from the recent reductions in US LIBOR rates. Approximately, 60% of our debt is exposed to variable rates through our bank facility, our receivable financing programs and the fixed to floating interest rates swaps on some of our senior notes. Finally, a lower effective tax rate added another $0.19 to the EPS improvement. The first quarter ETR was 25.4% compared to 36.6% in the prior year. However, for the full year of 2008, we expect only a modest EPS improvement from the tax rate. The year-over-year quarterly effect of the ETR should swing the other way in the back half of this year. Recall that the ETR for 2007 was 24.4% for the full year, but it declined in each successive quarter during the year ending with a fourth quarter rate of only 15%. The ETR is a year-to-date calculation and can vary significantly quarter-to-quarter. Now, let's move to the more detailed financial review by turning to chart number four, the net sales reconciliation. Total sales for the quarter were $1.961 billion with segment sales up $257 million, up more than 15%. Foreign currency translation was the largest contributor to the segment's sales increase. This has been the case for the past six quarters with continuing US dollar weakness. In this most recent quarter, the $187 million translation impact on the sales line represented an 11% increase. However, the most significant operating measure was the $119 million increase in sales from higher price and the product mix. This represented an increase of about 7% over 2007 and was almost 300 basis points better than the comparable first quarter 2007 increase over 2006. Looking forward over the balance of the year, we expect the average percentage price change will remain about in the same range although there will be some regional variation as contracts are renegotiated at different times. The revenue impact in the quarter from lower sales volume was $49 million or about a 3% decline compared to prior year. While this decline was not unexpected, we do not have enough data points at this time to determine if this is a trend. Many factors could have contributed to the change. Easter fell in March this year instead of April. The economic slowdown may have affected some customer orders, and you always had the naturally occurring noise from the effects of weather and competition. The sales volume discussion provides a good point transition to chart number five for our review of the segment operating profit reconciliation. First quarter 2008 segment operating profit from our four regions was $322 million, up $112 million or 53% from first quarter 2007. The $49 million decline in sales volume experienced this quarter resulted in a $12 million profit decline, as you can see on the first line in reconciliation. The relationship between the volume decline and the profit decline was about 4 to 1. Meanwhile, a $119 million increase in sales from price and product mix comes straight through to the profit reconciliation as a $119 million improvement. The net positive effect of volume and price in the first quarter of 2008 is very consistent with our value pricing strategy. The next reconciling line item is manufacturing and delivery. Included in this category are the effects of production volume, productivity, inflation, warehousing and transportation. Not included are the effects of sales volume and the translation impact of foreign currencies, two factors that are broken out individually on their own lines. For the first quarter of 2008, manufacturing and delivery was unfavorable by $55 million. This increase in cost represented about 3% of last year’s sales. And when you compare this to the 7% increase from price and product mix over last year sales, you see the two major factors at work in the 400 basis point improvement in profit margin. Now, I would like to take a few moments to expand on inflation we are experiencing and how it is changing our expectations. During our 2007 year-end earnings call three months ago, we shared a projected inflation range from $250 million to $300 million for the year 2008. At that time, oil was bouncing between $90 and $100 per barrel while today it is floating at $120. The NYMEX forward strip for natural gas was $8.25 then, and today it is over $10. Diesel fuel was $2.70 a gallon and now it is almost $4, so really impacting transportation costs. But this point in time, we have shifted our 2008 inflation range upward by $50 million to $75 million. So our new range is $300 million to $375 million Now, moving to the next line item, currency translation offered a favorable $35 million effect. It is another external variable that can significantly impact our results, but more than 70% of our business is outside the United States. At today’s exchange rates, the translation benefit should basically be a front half 2008 impact with little benefit in the back half of this year. So you can see the relationship between the US dollar, the euro and the Australian dollar over the last five quarters in chart number eight. The next line item is the catchall, other. This is the compilation of all the non-operating items that float through cost of goods sold and other income and expense. In this quarter, the $25 million improvement came in part from the non-recurrence of some 2007 asset write-offs. Also, we had some favorable balance sheet adjustments in the first quarter of 2008. The last item I'd like to mention on this chart is the corporate retained costs and other category. You see a swing on this line between years from an expense of $27 million in 2007 to income of $2 million in 2008. You may remember during the year-end call that I explained we were making some allocation changes to help bring closer alignment between internal and external reporting. We have increased the allocation of corporate costs, which represents a benefit of about $8 million per quarter. The offsetting cost charges are reflected as higher operating expense in each of the business segment results. Corporate retained costs also include the non-cash US pension income or expense, which will be about a $5 million year-over-year improvement in each quarter. The balance of the quarterly gain is due principally to the absence of any large-insurance claims against our captive subsidiary in 2008 and from the profit on the sale of equipment to two glass licensees in this quarter. For the balance of the year, we expect a more normalized retained cost to be an expense between $5 million and $15 million per quarter. Now, let's turn to chart number six for our free cash flow review. I'll start with the bottom line of this chart, which shows a first quarter 2008 cash performance, $48 million better than the prior-year quarter. And moving up the chart to the line that shows cash provided by continuing operations, you see a $20.7 million positive, which is the first time since 2002 we have been positive in a first quarter. Of course, the $174 million in earnings from continuing operations, a $119 million improvement over prior year, is driving the cash results. And let me add some background on the other three key components in our free cash flow, asbestos spending, change in working capital and capital spending. Asbestos-related payments this quarter remained on a par with the first quarter of 2007 at $40.2 million. Included in the first quarter payments was a $2 million reduction in the balance of previously settled, but unpaid claims. Only a small portion of our first quarter asbestos payments related to the company's proactive legal strategy to reduce risk and accelerate asbestos resolution on favorable terms. Nevertheless, this strategy continues and additional expected spending is reflected both on the current liability portion of our balance sheet as well as in our full-year cash flow projection. New filings in the quarter were down 33% from prior year. The reduction was due to the continued decline in filing of non-malignant claims. I want to emphasize that we don't react to quarterly fact patterns with this long-tail liability. We exited the business 50 years ago and have been dealing with the legal issues for almost 30 years. For OI, this remains a limited declining liability, which we will continue to manage in a conscientious and responsible manner. Now, the change in working capital was a use of cash as it is every year in the first quarter due to the seasonal pattern of our business. The increase in the first quarter of 2008 was $44 million higher than during the first quarter of 2007. This was due to higher selling prices and inflation working their way through receivable and inventory balances. We also saw the impact of higher finished goods inventory, which reflected the reduced shipments that occurred at the end of March. The last key cash component was capital spending of $45 million, which was $13 million higher than last year's quarter. This increase was in line with our 2008 capital spending guidance, which is 80% to 85% of depreciation and amortization. If you look at the D&A line, you see a $16 million year-over-year increase in what should be a relatively flat comparison. What is happening to both D&A and capital spending is the impact of foreign exchange rates. So this is why the capital guidance shared with you is a percentage between these two categories and not an absolute number. Before I wrap up our free cash flow discussion, let me offer the following forward-looking view. At the beginning of this year, our management team expected that free cash flow would exceed $425 million, which is about $100 million higher than it was in 2007. We're increasing our cash flow expectations to a range of $500 million if, and this is a significant if, exchange rates and inflation stay at their current levels. Before I pass the call to Al, I want to address something that has been weighing on my mind for the last several months. The progress that this company has made continues to exceed our expectations. And I know that some of you have had difficulty modeling because of that. As I said at the beginning of the call, we are in uncharted territory. We've undergone a significant transformation in the last 18 months, and to be honest, it's sometimes hard for many of our own team to really believe that we have fully righted the ship and are sailing ahead. Some think it must still be taking on water somewhere. This is a normal part of evolution that organizations experience when going through such major change. So, although this is uncharted territory we're very confident of the course and we are thrilled with the positive results we're seeing. And we will continue to do our best to talk openly about the trends and key drivers that could impact our business and the markets. Now, I'd like to turn the call over to Al.

Thank you, Ed, and good morning to all of you on the call. It is obvious from the numbers that we again had a good quarter and that the direction we embarked upon a year ago continues to bring much improved results. It is equally apparent that the rate of improvement is progressing more rapidly than we had anticipated at the beginning of last year. Despite the analytical work we did prior to embarking upon this course, strongly favorable market conditions have accelerated our progress beyond our initial expectations. We have benefited from a good supply and demand balance in the market and the fact that competitors in and outside the glass industry have faced their own challenges with increasing energy and raw material cost. This meant that the threat of substitution by other suppliers of glass and alternative materials was less severe than we had anticipated. Many of our competitors in the rigid packaging market and in the glass segment now find themselves in a profoundly different economic situation than they faced several years ago. Resins, steel, aluminum have seen such dramatic cost increases that all of those companies have had to revisit their business models. That was also the case for glass containers, although the industry came rather belatedly to that realization. To a certain extent therefore, implementation of our business strategy has been enabled by a larger overall trend in alternative packaging materials. When you look at our margin evolution over the last couple of years, it is clear that when coming out of several years of decline, ones initial momentum can create rather dramatic year-over-year improvements. But we must keep in mind that even though we will continue to progress rather significantly in full-year over full-year comparisons, a quarterly year-over-year evolution is eventually going to show a less dramatic differential. The first quarter comparison is aided by the fact that during the first quarter of 2007, we were just setting the stage for margin improvement, very little execution had occurred. Our progression over the subsequent quarters of 2007 and through the first quarter of this year combined with a considerably weaker U.S. dollar over that period have made for a fairly easy comparison. Comparisons will become more complex as the year progresses. Yet, we are optimistic about our future growth. We feel we have created a strong foundation and there still is room to build. As some of my colleagues are fond of saying, there is a quite a bit of runway left and we expect that runway to extend well beyond 2008. The inflationary pressures that Ed discussed earlier confirm that many of the same market forces that led the rigid packaging industry to re-examine its business model are still very much in play. These pressures will continue to support the changes we are trying to make in the way our company approaches the market. As we had discussed in last quarter's conference call, we expect the energy component of cost to be a significant driver of our inflation in Europe, Asia Pacific and now the Americas as well. Raw materials, labor and transportation will add cost pressures in all regions. Nevertheless, at this point we believe we have appropriately planned for inflation even though as Ed explained, it may end up higher than our original estimate. Our volumes for the first quarter were down somewhat, yet all of the shortfall occurred in March. We will have to see in the next quarter whether that was a result of pricing actions and adjustments we're making to our manufacturing footprint or something more simple such as when Easter happens to fall on the calendar. Whatever the reason may be, our volume value trade off decisions continue to provide us with a margin and profitability growth we projected. Now, let me talk a bit about our performance by region. In north, our largest region, our results improved considerably over the last year driven by productivity increases, price mix improvements, and favorable currency adjustments. While volumes were stable earlier in the quarter, the Easter holiday considerably impacted European volume in March compared to last year when Easter fell in April. Nevertheless, the market demand for products appear to remain strong and our pricing and contract negotiations have left a solid progress in the repositioning of our pricing value points. Price and mix combined for a high-single digit percent improvement over the first quarter of last year. Actual price increases in individual cases significantly exceeded that percentage when the pricing for a particular product was vastly below our targeted value point. We have placed quite a bit of emphasis on more timely pass-throughs of particularly volatile cost components in negotiating these new agreements. As expected, we saw some weakness in Germany, the U.K. and Spain due to our pricing action, which resulted in some volume migration to competitors during the typically lower demand [inaudible]. This primarily affected our food and beer sales while wine and spirit volumes remained more stable. Progress in North America was in stark contrast to what we experienced in Europe. Our ability to recover our lost margins here is still considerably hampered by contractual commitments that date back many years. In some cases, our customers have been supportive and we've been able to transition to new agreements ahead of time. We do expect to see some positive impact from these in the course of this year. And we started the negotiation process with customers whose contracts end within the next two years, and the longer it takes to renew the more profound the change will have to be. In addition to the rampant energy and the raw material cost increases we are experiencing globally, we are also faced with escalating employee related cost in North America. This includes wages, healthcare and other employee benefit costs. These inflationary costs combined with the legacy contractual commitments I mentioned earlier, have resulted in margin deterioration, which if not corrected has the potential to create profound supply, demand imbalances in the region. We will maintain or reduce our manufacturing base as appropriate to cover our existing commitments with the expectation that we will be able to return to a performance profile that is more in line with the rest of the world over the next two to three years. However, given the current market conditions, new capacity in the region cannot be economically justified by us at this time. Results in the first quarter were impacted by a few of our beer customers shifting some volume to our competitors. Those were anticipated and related to the closing of our Scoudouc facility, which we announced during the last quarter. In addition, several [ph] weeks delay in the startup of one of our West Coast furnace rebuilds required some significant volume shipments from the east to cover the customer base on the West Coast leading to much higher rate cost. Now, let's turn to Latin America. The Latin American region had excellent results in the first quarter. Our Latin American colleagues continue to inspire our other regional teams with their processes and the approaches, and we are very proud of their accomplishments. We are particularly pleased with the new product development, which remained strong in all countries of the region. As Ed mentioned, we officially opened our new plant in Lurin, Peru earlier this year, and at the same time we announced we would double that new factory’s capacity by the second quarter of next year. This is needed to support the strong growth in the agricultural sector and the beverage market in the country. We've also decided to establish a manufacturing and engineering center there. This group will work in conjunction with the other regional centers to serve as engineering and for some of the design consultants to our operations around the world. Both of these announcements reflect the outstanding performance we’re seeing from our team in Peru. Cost increased pressures are coming mainly from energy and labor. The international economic scenario is also adding some inflationary pressures. This affects all countries in the region, but is still relatively mild with the exception of Venezuela, which showed an inflation rate of 28% during the last 12 months. Asia-Pacific has made considerable progress in their initial efforts to address margin deterioration. As a result, like Europe their price and mix profile improved with a high-single digit impact over the first quarter of last year. Demand for glass remained strong and customers, particularly in Australia and New Zealand, want to ensure that the future demand is covered by adequate supply agreements. The lower wine harvest in Australia is having some effect that’s mainly impacting the volume of bulk shipments of wine. The demand for beer bottles in New Zealand is up considerably over previous year. Reported segment operating profit from this region like others has benefited considerably from currency developments over the last 12 months. Energy input costs are rising across the region. Yet in China, we still see a strong practice of switching between glass suppliers to avoid cost pass-throughs. We expect that this will change in the course of this year when the pressure on them simply becomes too great. As we mentioned in earlier calls, we're actively pursuing the creation of a pipeline of potential acquisition candidates in Latin America, China, and Southeast Asia, as well as in Eastern Europe Now, let me try to coalesce these regional perspectives into a more holistic picture. Over the last 12 months, we have gone through enough new contract negotiations with large, medium, and small customers to draw some conclusions. In all three of these categories and across countries, regions and market segments, from beer to soft drinks to food, we have seen that the necessary step change is possible. During one of our previous earnings calls, we said that our pricing experience in Europe was going to be pivotal in determining the validity of our new value-based approach. I believe that the success we have seen in Europe is a very important positive signal, especially since it is our most competitive region. Even though the development in North America continues to lag behind the progress we've made in all the other regions and will most likely move along the three-year timeline trajectory that we predicted at the beginning of last year, we are confident that our margins here will ultimately see similar corrections. So here is the summary, overall demand continues to be very solid in a balanced supply-demand environment. We are making good progress with our pricing corrections. Our productivity improvements in manufacturing as well as in supporting operations are on a very positive trajectory, and these are actually likely to strengthen with Lean Six Sigma implementation progressing on a broad basis throughout the organization. Continued input cost inflation supports our position that fundamental corrections in the pricing points for our products are necessary and justified. Alternative packaging forums are facing similar challenges. They are as or even more significantly exposed to the combination of increasing energy and transportation cost and strong demand for their base raw materials from other competing end-use applications. We expect that 2008 will bring challenges, particularly with regard to rising raw materials and energy cost. But we believe the market conditions will remain relatively favorable. We anticipate a solid expansion of our cash flow due to the ongoing implementation of our pricing strategy and productivity improvements and we expect to see positive results from our stepped-up marketing activities. The last time we spoke, I told you we had righted our ship. And now to continue with my naval analogies, we're building a stronger, faster and leaner ship. We are in the process of defining where we want to go, and we see many opportunities. We're looking for possibilities to grow in promising markets. We are working more closely with customers to offer innovative solutions to help them differentiate their products in the marketplace, and we are working on ways to boost awareness of the environmental and economic benefit of glass. For us, the coordinated are all beginning to align and we are optimistic about the journey ahead. I look forward to talking with you more about that journey at the conference in May, but for now let’s open it up for questions on our first quarter performance. Natasha, you can open the line for questions now. Question and Answer

[Operator Instructions]. Your first question comes from George Staphos with Banc of America.

Thanks everyone. Good morning. Really terrific quarter guys and I appreciate all the detail as well. I guess the first question I had, you know, more near-term, can you let us know if you have that detail? What kind of trends you're seeing thus far in April in volume in Europe and in the States, and how you feel about your inventory levels at the present time. The second question is more bigger picture. Do you feel if perhaps inflation begins to moderate over the next couple of years, that will... will it help you on the cost side, might perhaps be a bit of disadvantage for you relative to the effect it might have on opposing materials. Thanks.

All right. Well, with regard to April, we don't have a final numbers yet, but what we have been tracking through the middle of the months indicates that the effect of Easter really is playing through again. So, we're seeing that correction. Now, with regard to longer term, many industries of course over the past 20 years have gone through long deflationary periods and that always is a very difficult environment for pricing and for eventual shifts from one packaging material or one product to another product. So, I think at this point in time, let's focus on the opportunity that we see that this significant inflation has created for us with just, take the correction that most probably was already overdue for another 10 years or so that make those corrections and I think will have to deal then if the overall parameters changed five years from now or three years from now then with that environment, but I think given the demand picture and the overall projections for raw materials as well as for energy five years, 10 years, down the road. It looks to me like it's going to be quite a while off.

Thanks. I'll turn it over. I'll be back. Thanks.

Your next question comes from Ghansham Panjabi with Wachovia.

Hey, guys. Good morning.

Good morning.

You know, with regards to your North American EBIT margin decline, how much of this has increased corporate expense allocation relative to your previous reporting style and how should we expect, how should we model margins throughout the rest of the year. Should we expect some more incremental price in 2Q onwards or did most of that occur in the first quarter?

Okay. I'll let that Ed talk to the specifics, but I think fundamentally what is happening is the same process that benefited those last year. We came last year out of a year of high inflation in 2006, and therefore the corrective price adjustment formulas then kicked in 2007, when inflation was a little bit lower. So, this year we are most probably going to see the reverse effect. We had a lower base rate of inflation last year. So the EAF is at a lower rate and yet inflation -- actual inflation is running at a higher rate. So, that's compressing some of the margin and that's the model that we are trying to change and correct and we will correct over the next two years. Now with regard to the individual questions, Ed can give you some more detail.

Hi Ghansham. In our... in the last table where we have the segment operating result, we talked about it being about $8 million a quarter shift out of corporate to the business units and in North America we did about a third of that.

One third of that. Okay and just in terms of my follow-up question, could you just sort of comment on the customer sentiment at this point versus maybe late last year. There is some evidence from some of your major customers that consumers are trading down in the beer categories. Just some general thoughts that would be helpful. Thanks.

I think it really varies from region to region. And I think what we are seeing for instance in the wine region and as well as in the food region, customers in that area are also suffering significantly from much higher cost for products that are prior to the harvest and that are required also transportation cost or having a significant impact. All of those are causing cost pressures that of course let people look very carefully at the consumption of all these components. But I would say from a consumer standpoint, we continue to see more and more individual customer specific excesses or failures in the marketplace rather than an overall trend.

Okay. Thank you.

Your next question comes from Timothy Thein with Citigroup.

Hi, good morning. Thanks, and congrats again on a good quarter guys. My question is on the... first, in terms of your head rate in North America on the natural gas side. Did that change from where it was at the end of the fourth quarter and second question, should… any reason why we shouldn't expect… again we have got inflation presently going ahead here, and they are picking up in the next couple of quarters. Should we still expect to see a similar pattern of seasonal improvement from a margin standpoint, again assuming today's exchange rates, again in the second and third quarters?

Okay. Tim. I'll take these two questions. But first, our North American head position stayed where it is… at about 50%. As you could imagine, we were laying it in over the past year or so. So, it's kind of a mid 80-ish kind of $8 number. As far as, yeah, we will see some margin pressure now going through the year, because not all but the majority of our contracts had been negotiated. So, you will see I think that inflation being a challenge for us as going through the year, but not the dramatic as we have put in our comments, but not the dramatic gift that you might have… given the fact we have incorporated some [inaudible]. We've some flexibility today that we didn't have a couple of years ago.

Okay. Thank you.

Your next question comes from Claudia Hueston with JP Morgan.

Thanks very much. Good morning.

Good morning, Claudia.

Just wanted to talk for a minute about free cash flow. I was hoping you would provide a little bit of color on how you anticipate allocating the cash, and then maybe just give a little detail on the kinds of acquisitions you may be considering? Thanks.

Okay, I'll take step one and then AI can jump in on the second piece. You now, given I think the capital markets today, we are very pleased with the position we are in, in terms of our liquidity and balance sheet. But we also think the best thing we can be doing at this time is continuing to strengthen that balance sheet and use our free cash flow to take out our 2008. You'll see some high cash balances on our -- in our balance sheet. That cash is [inaudible] around -- so in two weeks we can take out a $250 million of notes. We'll continue to really strengthen the balance sheet for the year. With regard to potential acquisitions, I believe I have mentioned in one of the last calls at the areas that we are focusing on our several countries in Latin America, the South Eastern and Eastern part of Europe as well as in Asia-Pacific with our preference in China. We firmly see a pretty good list of potential candidates and we still have to go through the process and see first of all which ones would be willing to consider a change in ownership and also more importantly for us, how could we fit them more optimally and to our overall structure and what would be the additional benefit that we could provide through an acquired entity. More than that, it is very difficult to talk about it at this point in time, because should we be in discussions with anybody, they would all be subject to confidentiality agreement. So, I could not really talk about it.

That's helpful. Thank you very much.

Your next question comes from Rick Skidmore with Goldman Sachs.

Good morning. I just wanted to follow up on the pricing side, as you look at pricing through the year and what you've done on the contracts to renegotiate the pricing, do you expect pricing to accelerate from here, so that 7% skids to 8%, or do you expect it to slow down? And within that in your negotiations… you have been able to negotiate the ability to raise prices through the year to offset some of the energy inflation that you are seeing?

Well, I think the answer to the first question is really going back to what I had indicated, which was that we will see a similar rate of improvement in pricing as we saw in the first quarter, as a range which of course was indicative that there still was some underlying improvement, because last year we saw some improvements in the quarters as well. But I don't think that you will see a significant step change from what you saw in the first quarter. And I think that is indicative also to some extent for how much we feel we can pass through to the marketplace, based on the contract negotiations and the new contracts that have been put in place. So, we certainly have not been successful in all situations to negotiate that, but in quite a few we have been successful, and we will see as the year develops on how quickly and how reactive we can be to the inflation rates that we are going to see in the course of the next three quarters.

Okay and then just a follow-up. A quick question on your inflation number for 2008 is 300 out of 375. Is that a net number, net of your productivity gains or is that a gross inflation number and we should think about yours being Six Sigma being a net offset to that.

Rick, that's a gross number. So, we are seeing things that we would expect range between 5% and 7%, which seems pretty broad, but we also have a lot of volatility in the market right now.

All right. Thank you.

Your next question comes from Chris Manuel with KeyBanc.

Good morning gentlemen and congratulations on a terrific quarter.

Thank you Chris.

Most of my questions are answered, but I do have a couple of follow-ups. First, if I can just clarify something. I think with respect to pricing what you talked about, most of your prices in place for this year, sort of the 7-ish percent or so improvement you saw here in the first quarter should be sustainable for the full year or as you get to the back half of the year, if I remember correctly, your price had stepped up in the third and fourth quarter of last year. So, should we anticipate that it stayed at 7-ish sort of range for the full year, or as we get to the back half of the year, does it actually start to move down a little bit potentially as you anniversary some of your previous increases?

Well, the comparisons will become more difficult as we move [inaudible] with what we have underway at this point in time, where we are still trying to put in place [inaudible] 6% to 7%, you will most probably be in the right range.

Okay. That's very helpful…

This line item is also price and product mix, and we've been doing some bottom slicing. So, it comes back to all my empathy for you guys or you gals -- you try to model us. You've really two moving pieces on that. So, that's why we would like to talk about a range that has a plus or minus.

That's helpful. My second question has to do with some of the hedging strategies. I know in North America, you traditionally hedge [inaudible] gas moving forward. In Europe, you've usually done less hedging, because most are I think heating oil and such. But have you begun to employ any strategies over there to try to lock in some of your heating oil cost at least on… more annual type source of schedules to match with, when you coincide pricing, have you still let a lot of that to sort of flow?

We've tried to do the former of more longer-term contracts or annual contracts, being in the spot market. So, that is going to be why we feel some comfort in our inflation numbers. While we move the range up, the fact is we had a lot of annual contracts that were in place at the end of the year, which gives us our first range of inflation. So, it's the volatility of the unhedged portion that we put into the… that's why we moved the range up.

Okay. But at this point, you feel that you've got most of your buy over there locked in the disinflation range you feel pretty good about?

No, we don't. That's why we've said, we've got more than historically, but we don't have most, do I have a range? I really don't know where things are going. I mean, I think my opening comments on inflation is that, we didn't think where we are today would be where we would be three months ago. We thought we had pretty much moved to the top of the curve, where we are going to stay in that range and that not continue moving forward.

Right. Okay, perfect. Thank you very much gentleman and good luck.

Thank you.

[Operator Instructions]. You have a follow-up question from George Staphos with Banc of America.

Thank, hi guys. Can you give us maybe a bit more quantification both in terms of progress and the benefit you are getting from Lean Six Sigma and productivity efforts? Can you give us at all perhaps what that benefit might have been in 1Q and then I had a non-related follow on?

Well, George, I had indicated in one of the earlier calls that we were going to start reporting on Lean Six-Sigma in the third quarter of this year. We are seeing of course some numbers. But they are just starting, and so it's not yet really meaningful for any projections or any modeling. So, give us another two quarters and we'll be happy fairly openly about what we're seeing as benefits and as potential.

Okay. Apologies on that. But that would also suggest then really that number that we saw the 55 million or so was really inflation both growth and net.

Well, but we also have a lot of productivity improvements that I am asking quite a bit of the inflation that actually took place. In fact what you should be looking at is look at the total number for this year now and the range, which is more than double the inflation that we saw last year. I think that's really the underlying force that was.

Okay. And that productivity would be largely residuals from BFN or how would you characterize it?

I think -- and you may recall that we had a year and a half ago at the investor conference when the question was, what are you going to do differently in the future and what you are seeing there is what we're doing differently and Rich and his team have done a terrific job of looking at best-in-class operations within our organization and taking, drawing lessons from that and moving it into other products of the company. And I think in May we will talk more specifically about that and give you a fairly detailed evaluation, which would give you some of the markers that you are most probably looking for.

Okay. Last quick one. Over in Europe and taking you back I think on Ghansham's question, there has been again some more vocal discussion on pricing about some of your European customer. Is this the same old as we saw maybe a year or two ago, how would you characterize it? Thanks very much. Good luck in the quarter.

Yes. Well I think you'd typically find especially in the agricultural sector and customs in the agricultural sector where you have many small and just… customers that very often do not have a lot of ability to predict their needs and requirements, and if there suddenly is a tightness in the market place, they of course are shocked by the price environment that they find. And the agricultural sector being an important political base for many politicians in Europe, but naturally that we got some visibility and that we got some public discussion. We will see how it's going to evolve.

Thanks very much Al.

Your next question comes from Timothy Burns with Cranial Capital.

Al, Ed, Paul, good morning.

Good morning.

Great, great quarter. You guys have a lot of naval analogy on these calls. I am a land lover. But it seems you guys have gone from kind of a Sunfish to a royal cruise liner. And I guess, what I wonder is you are certainly throwing out some flags that it's not going to be as good as this for ever guys. But I guess the question is, there will probably be an improvement, but will the big improvement be more lumpy?

Now, I'm not really thinking more about lumpiness, I'm just saying that we have seen a dramatic improvement from where we were, but that also of course was dramatic, because we had a very low performance level.

Right.

The point really is that we will continue to expect performance and will drive full performance and that will have hopefully some consistency to it. But I think if you come from one year where you have a doubling or whatever of your numbers, then to double that again is going to be of course be much more difficult. And we still have to realize that quite a bit of the improvement that we're seeing is also due to the fact that we were significantly underperforming.

Got you. And you didn't talk much about either breakthroughs or developments in process technology, new products or marketing or is it not material this quarter? Or it is something you don't want to talk about?

It's not really that material this quarter, and of necessity those are always more longer term issues and longer term developments. So, it's very difficult to really specify it, a particular event in a given quarter. I talked a bit more about it when I talked about our annual results in the last conference call, and we will also touch on our new product development and some innovation at the conference in May.

And given the globality of this company, wouldn't that make sense to make Latin America the marketers, the US, the manufacturers, EU, the pricers and Asia Pacific the demand element?

Well. I think it's very difficult to take a particular skill and transfer it to other regions or to other environments. So, you have got to understand that what we are trying to do is understand the processes and the logic and the insides from those regions and apply those through the people and through the organization that we have in place. That may be perhaps a little bit more cumbersome a process, but I certainly think it has greater durability for an organization to make those changes that way.

Thanks. Al, bring some Tim Hortons to New York when you come.

Okay, well, Natasha our time is up. We want to thank everyone for joining us on the call. And hope you'll join us on the web cast in May. And our next conference call will be in July. Thank you.

This concludes today's '01 first quarter earnings release conference call. You may now disconnect.