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| BLL > SEC Filings for BLL > Form 10-Q on 5-Nov-2008 | All Recent SEC Filings |
5-Nov-2008
Quarterly Report
Management's discussion and analysis should be read in conjunction with the unaudited condensed consolidated financial statements and the accompanying notes. Ball Corporation and its subsidiaries are referred to collectively as "Ball" or the "company" or "we" or "our" in the following discussion and analysis.
BUSINESS OVERVIEW
Ball Corporation is one of the world's leading suppliers of metal and plastic packaging to the beverage, food and household products industries. Our packaging products are produced for a variety of end uses and are manufactured in plants around the world. Ball Aerospace & Technologies Corp. (BATC) supplies aerospace and other technologies and services to governmental and commercial customers.
We sell our packaging products primarily to major beverage, food and household products companies with which we have developed long-term customer relationships. This is evidenced by our high customer retention and our large number of long-term supply contracts. While we have a diversified customer base, we sell a majority of our packaging products to relatively few major companies in North America, Europe, the People's Republic of China (PRC) and Argentina, as do our equity joint ventures in Brazil, the U.S. and the PRC. We also purchase raw materials from relatively few suppliers. Because of our customer and supplier concentration, our business, financial condition and results of operations could be adversely affected by the loss of a major customer or supplier or a change in a supply agreement with a major customer or supplier, although our contracts and long-term relationships generally mitigate these risks. We are also subject to exposure from the rising costs of raw materials, as well as other inputs into our direct costs, although our contracts and long-term relationships help us to recover these costs in the majority of those circumstances.
In the rigid packaging industry, sales and earnings can be improved by reducing costs, increasing prices, developing new products and expanding volume. Over the past two years, we have closed certain packaging facilities in support of our ongoing objective of matching our supply with market demand. In 2009 we expect to complete the project to upgrade and streamline our North American beverage can end manufacturing capabilities, a project that in 2007 began to generate productivity gains and cost reductions in the metal beverage packaging, Americas and Asia, segment. We have also identified and implemented plans to improve our return on invested capital through the redeployment of assets within our worldwide system.
While the U.S. and Canadian beverage container manufacturing industry is relatively mature, the European, PRC and Brazilian beverage can markets are growing and are expected to continue to grow. We are capitalizing on this growth by increasing capacity in some of our European can manufacturing facilities by speeding up certain lines and by expansion. Our current expansion plans include the construction of a new plant in Poland, to meet the growing demand for beverage cans there and in central and eastern Europe. We are also considering additional can and end manufacturing capacity in Europe and in the PRC. Additionally, we recently announced a new one-line metal beverage can plant in our Brazil joint venture and are adding further can capacity in the existing Brazilian can plant. These Brazilian expansion efforts will be owned by Ball's unconsolidated 50-percent owned joint venture, Latapack-Ball Embalagens, Ltda., with the financing anticipated to be funded by cash flows from operations and incurrence of debt by the joint venture. We are delaying construction of our planned can plant in India due to current economic conditions in that country.
As part of our packaging strategy, we are focused on developing and marketing new and existing products that meet the needs of our customers and the ultimate consumer. These innovations include new shapes, sizes, opening features and other functional benefits of both metal and plastic packaging. This packaging development activity helps us maintain and expand our supply positions with major beverage, food and household products customers. As part of this focus, we installed a new aluminum bottle line, as well as a 24-ounce beverage can production line in our Monticello, Indiana, facility, both of which became operational during the third quarter of 2008.
Ball's consolidated earnings are exposed to foreign exchange rate fluctuations. We attempt to mitigate this exposure through the use of derivative financial instruments, as discussed in "Quantitative and Qualitative Disclosures About Market Risk" within Item 3 of this report.
The primary customers for the products and services provided by our aerospace and technologies segment are U.S. government agencies or their prime contractors. It is possible that federal budget reductions and priorities, or changes in agency budgets, could limit future funding and new contract awards or delay or prolong contract performance. We expect that the delay of certain program awards will have an unfavorable impact on this segment in 2009, and we are taking steps to adjust our resources accordingly.
We recognize sales under long-term contracts in the aerospace and technologies segment using the cost-to-cost, percentage of completion method of accounting. Our present contract mix consists of approximately two-thirds cost-type contracts, which are billed at our costs plus an agreed upon and/or earned profit component, while the remainder are fixed-price contracts. We include time and material contracts in the fixed price category because such contracts typically provide for the sale of engineering labor at fixed hourly rates. Failure to be awarded certain key contracts could adversely affect segment performance.
Throughout the period of contract performance, we regularly reevaluate and, if necessary, revise our estimates of BATC's total contract revenue, total contract cost and progress toward completion. Because of contract payment schedules, limitations on funding and other contract terms, our sales and accounts receivable for this segment include amounts that have been earned but not yet billed.
Management uses various measures to evaluate company performance. The primary financial metric we use is economic value added (tax-effected operating earnings, as defined by the company, less a charge for net operating assets employed). Our goal is to increase economic value added on an annual basis. Other financial metrics we use are earnings before interest and taxes (EBIT); earnings before interest, taxes, depreciation and amortization (EBITDA); diluted earnings per share; operating cash flow and free cash flow (generally defined by the company as cash flow from operating activities less capital expenditures). These financial measures may be adjusted at times for items that affect comparability between periods. Nonfinancial measures in the packaging segments include production efficiency and spoilage rates, quality control figures, environmental, health and safety statistics and production and shipment volumes. Additional measures used to evaluate performance in the aerospace and technologies segment include contract revenue realization, award and incentive fees realized, proposal win rates and backlog (including awarded, contracted and funded backlog).
We recognize that attracting, developing and retaining highly talented employees are essential to the success of Ball and, because of this, we strive to pay employees competitively and encourage their ownership of the company's common stock as part of a diversified portfolio. For most management employees, a meaningful portion of compensation is at risk as an incentive, dependent upon economic value-added operating performance. For more senior positions, more compensation is at risk through economic value-added performance and various stock compensation plans. Through our employee stock purchase plan and 401(k) plan, which matches employee contributions with Ball common stock, employees, regardless of organizational level, have opportunities to own Ball stock.
CONSOLIDATED SALES AND EARNINGS
The company has five reportable segments organized along a combination of product lines and geographic areas: (1) metal beverage packaging, Americas and Asia; (2) metal beverage packaging, Europe; (3) metal food and household products packaging, Americas; (4) plastic packaging, Americas; and (5) aerospace and technologies. Due to first quarter 2008 management reporting changes, Ball's PRC operations are now included in the metal beverage packaging, Americas and Asia, segment. The 2007 segment information has been retrospectively adjusted to conform to the current year presentation. We also have investments in companies in the U.S., the PRC and Brazil, which are accounted for using the equity method of accounting and, accordingly, those results are not included in segment sales or earnings.
Metal Beverage Packaging, Americas and Asia
The metal beverage packaging, Americas and Asia, segment consists of operations located in the U.S., Canada, Puerto Rico and the PRC, which manufacture metal container products used in beverage packaging, as well as non-beverage plastic containers manufactured and sold mainly in the PRC.
This segment accounted for 38 percent of consolidated net sales in the third quarter of 2008 (38 percent in 2007 including the impact from the $85.6 million legal settlement with Miller Brewing Company discussed below) and 40 percent in the first nine months (41 percent in 2007 including the impact from the legal settlement). Excluding the effect of the legal settlement, sales in the third quarter and first nine months of 2008 were 4 percent and 3 percent lower, respectively, than the same periods in 2007, primarily a result of 2008 decreases in North American volumes for both periods of approximately 6 percent. The decrease in North American sales volumes was due in part to lower unit volume sales to carbonated soft drink customers and a decision to discontinue sales of certain beer unit volumes, which did not provide sufficient profitability. This decrease was somewhat offset by sales volume increases in the PRC of 20 percent for the third quarter and 15 percent for the first nine months of 2008, respectively.
During the second quarter of 2007, Miller Brewing Company (Miller), a U.S. customer, asserted various claims, primarily related to the pricing of the aluminum component of supplied containers, and on October 4, 2007, the dispute was settled in mediation. Miller received $85.6 million ($51.8 million after tax) on settlement of the dispute and Ball retained all of Miller's beverage can and end supply through 2015. Miller received a one-time payment of approximately $70 million in January 2008 with the remainder of the settlement to be recovered over the life of the supply contract through 2015. Segment sales and earnings in 2007 were reduced by the $85.6 million charge. Additional details regarding the legal settlement are available in Note 5 accompanying the unaudited condensed consolidated financial statements included within Item 1 of this report. On July 1, 2008, Miller's business was combined with the U.S. business of Coors Brewing Company, which we also supply, to form MillerCoors, LLC.
Segment earnings were $76.4 million in the third quarter of 2008 compared to a loss in the third quarter of 2007 of $14.4 million (earnings of $71.2 million excluding the legal settlement). Earnings were $224.4 million in the first nine months of 2008 as compared to earnings in the first nine months of 2007 of $176.6 million (earnings of $262.2 million excluding the legal settlement). Excluding the $85.6 million settlement and business consolidation charges, the earnings in 2007 exceeded 2008 by 13 percent primarily due to raw material inventory gains of approximately $52 million realized through the first nine months of 2007, which did not recur in 2008. Earnings in the third quarter and first nine months of 2008 were negatively impacted by lower North American sales volumes, which were partially offset by the increased sales volumes in the PRC. Net pretax charges of $3.4 million and $0.6 million were incurred in the second and third quarters of 2008, respectively, related to the segment's business consolidation activities (see comments below), further reducing earnings for the first nine months of 2008. Positive cost impacts from the new end technology project and other cost optimization measures partially offset the prior year non-recurring inventory gain, the unfavorable net sales volume decrease and the business consolidation charges.
The company announced in the second quarter of 2008 that by the end of 2008 it would close a metal beverage packaging plant in Kent, Washington, and recorded a pretax charge of $11.2 million ($10.6 million in the second quarter and $0.6 million in the third quarter). The closure has now been completed and is expected to result in fixed cost savings of approximately $11 million in 2009 and annual, fixed-cost savings of approximately $16 million beginning in 2010. Also in the second quarter of 2008, a gain of $7.2 million was recorded for the recovery of previously expensed pension, employee severance and other benefit closure obligation costs no longer required. This reflects a decision made in the second quarter to continue to operate existing end-making equipment and not install a new beverage can end module that would have been part of our multi-year project. Additional details regarding business consolidation activities are available in Note 6 accompanying the unaudited condensed consolidated financial statements included within Item 1 of this report.
We continue to focus efforts on the custom beverage can business, which includes cans of different shapes, diameters and fill volumes and cans with added functional attributes (such as resealability) for new products and product line extensions.
Subsequent Event
On October 30, 2008, the company announced the closure of two North American metal beverage can plants. A plant in Kansas City, Missouri, which primarily manufactures specialty beverage cans, will be closed by the end of the first quarter 2009 with manufacturing volumes absorbed by other North American beverage can plants. A plant in Puerto Rico, which manufactures 12-ounce beverage cans, will be closed by the end of the year. A pre-tax charge of approximately $52 million ($32 million) will be recorded to reflect these plant closings, of which approximately $45 million is expected to be recorded in the fourth quarter of 2008 with the remainder recorded in the first quarter of 2009. The charges include approximately $19 million for employee severance, pension and other employment benefit costs and approximately $33 million primarily related to accelerated depreciation and the write down to net realizable value of certain fixed assets and related spare parts and inventory. Cost reductions associated with these plant closings are expected to exceed $30 million in 2009 and be $9 million cash positive upon final disposition of the assets.
Metal Beverage Packaging, Europe
The metal beverage packaging, Europe, segment includes metal beverage packaging products manufactured in Europe. This segment accounted for 26 percent of consolidated net sales in the third quarter of 2008 (24 percent in 2007) and 25 percent in the first nine months (22 percent in 2007). Segment sales in the third quarter and first nine months of 2008 as compared to the same periods in the prior year were 13 percent and 18 percent higher, respectively, due largely to approximately 5 and 8 percent higher volumes, respectively, consistent with overall market growth; higher sales prices in both periods; and foreign currency sales gains of 10 and 13 percent on the strength of the euro. In both periods, these positive impacts were offset by certain small unfavorable changes. Higher segment sales volumes were aided by the growth in Europe of specialty can volumes, including the successful introduction of the Ball sleek can into Italy. The slow return of the metal beverage can to the German market, following the mandatory deposit legislation previously reported on, is being offset by stronger demand outside Germany.
Segment earnings were $76.7 million in the third quarter of 2008 and $201.9 million in the first nine months compared to $74.8 million and $197.7 million for the same periods in 2007, respectively. Earnings in the third quarter of 2008 were positively impacted by an increase in net margins of $10 million due to the combined impact of increased sales volumes and price recovery initiatives that exceeded the negative impact from product mix, as well as approximately $7 million related to a stronger euro. These improvements were offset by $8 million of higher other costs including a negative impact from the conversion of the pound sterling to the euro. Earnings in the first nine months of 2008 were positively impacted by $35 million due to the combined impact of increased sales volumes and price recovery initiatives that exceeded the negative impact from product mix, as well as approximately $24 million related to a stronger euro. These improvements were offset by $19 million of higher other costs including a negative impact from the conversion of the pound sterling to the euro. Approximately €5.1 million ($7 million) and €26.2 million ($35.1 million) of reductions in cost of sales were recognized during the third quarter and first nine months of 2007, respectively, for insurance recoveries related to business interruption costs as a result of an April 2006 fire in one of the company's German plants.
Metal Food & Household Products Packaging, Americas
The metal food and household products packaging, Americas, segment consists of operations located in the U.S., Canada and Argentina. The segment includes the manufacture and sale of metal cans used for food packaging, aerosol cans, paint cans and decorative specialty cans.
Segment sales were approximately 18 percent of consolidated net sales in the third quarter of 2008 (18 percent in 2007) and 16 percent in the first nine months (16 percent in 2007). Sales in the third quarter increased 4 percent over the same period in 2007 and remained relatively flat for the first nine months of 2008 in comparison to sales in the first nine months of 2007. The increase in sales in the third quarter of 2008 was due to higher selling prices, while volumes remained flat period over period. The consistent sales in the first nine months of 2008 compared to the first nine months of 2007 were the result of higher prices offset by an approximate 6 percent decrease in sales volumes in the first nine months of 2008 due to decisions by management to discontinue low margin business, resulting in the announced closure of our Commerce, California, and Tallapoosa, Georgia, facilities.
Segment earnings were $11.3 million in the third quarter of 2008 compared to $14.5 million in the third quarter of 2007 and $40.4 million in the first nine months of 2008 compared to $25.4 million in 2007. The decrease in earnings in the third quarter of 2008 was due primarily to a charge of $4.5 million related to business consolidation activities (see comments below) predominantly for the closure of a plant in Commerce, California, during the quarter, which was offset by improved pricing and better manufacturing performance. The improved performance in the first nine months of 2008 was primarily related to improved pricing and better manufacturing performance offset by the negative impact of 6 percent lower sales volumes and the charge associated with the closure of the plant in Commerce, California.
The company announced in the fourth quarter of 2007 that by the end of 2008 it would close metal food and household products packaging plants in Commerce, California, and Tallapoosa, Georgia, and redeploy certain of those assets to other food and household facilities, including Oakdale, California, and Chestnut Hill, Tennessee. When completed, the actions are expected to yield annualized pretax cost savings in excess of $15 million and improve the aerosol plant utilization rate to more than 85 percent from about 70 percent. Additional details regarding business consolidation activities are available in Note 6 accompanying the unaudited condensed consolidated financial statements included within Item 1 of this report.
As reported in our second quarter Form 10-Q, during the third quarter our aerosol business experienced a tinplate supply issue due to a major supplier's failure to deliver committed metal. While this matter affected a limited, seasonal part of our product mix, it caused a supply disruption with some of our customers that resulted in lost sales and profitability in the quarter. We have made every effort to fulfill our customers' requests and minimize the impact on our customer base. We are now receiving the necessary tinplate to produce products for our customers. Future raw material supply arrangements are scheduled, and we are working through the remaining production issues caused by the steel shortage.
Plastic Packaging, Americas
The plastic packaging, Americas, segment consists of operations located in the U.S. and Canada (through most of the third quarter of 2008), which manufacture polyethylene terephthalate (PET) and polypropylene plastic container products used mainly in beverage and food packaging, as well as high density polyethylene and polypropylene containers for industrial and household product applications. Manufacturing operations ceased in Canada during the third quarter of 2008 with the closure of the Brampton, Ontario, plant.
Segment sales accounted for 9 percent of consolidated net sales in the third quarter of 2008 (10 percent in 2007) and 10 percent in the first nine months of 2008 (10 percent in 2007). Raw material cost increases passed through to customers accounted for approximately $13 million of net sales for the third quarter of 2008 offset by approximately 13 percent volume loss compared to the same period last year. For the first nine months of 2008, raw material cost increases passed through to customers accounted for approximately $49 million of net sales offset by an 8 percent volume loss compared to the same period last year. The volume loss included decreases in carbonated soft drink and water bottle sales due, in part, to lower convenience store sales by our customers, which were partially offset by higher sales in specialty business markets (e.g., custom hot-fill, alcohol, food and juice drinks) and a decrease in preform sales due in part to the bankruptcy filing of a preform customer.
Segment earnings of $1.3 million in the third quarter of 2008 and $7.5 million in the first nine months were lower than prior year earnings of $7.7 million and $17.1 million for the same periods primarily due to the previously mentioned volume losses, $4 million in restructuring charges for the third quarter of 2008 and $8.3 million for the first nine months of 2008 related to the closing of the Brampton, Ontario, plant (see comments below) and a $1.8 million charge due to a customer bankruptcy filing during the second quarter of 2008.
The company announced in the second quarter of 2008 the closure of a plastic packaging manufacturing plant in Brampton, Ontario, which employs 90 people. The Brampton operations will be consolidated into the company's other plastic packaging manufacturing facilities in the United States and are expected to result in annual, fixed-cost savings of approximately $4 million beginning in 2009. Additional details regarding business consolidation activities are available in Note 6 accompanying the unaudited condensed consolidated financial statements included within Item 1 of this report.
In view of the substandard PET margins, we continue to focus our efforts on price and margin recovery initiatives, as well as PET development efforts in the custom hot-fill, beer, wine, flavored alcoholic beverage and specialty container markets. In the polypropylene plastic container arena, development efforts are primarily focused on custom packaging markets.
Aerospace and Technologies
Aerospace and technologies segment sales, which represented 9 percent of consolidated net sales in the third quarter of 2008 (10 percent in 2007) and 9 percent in the first nine months (11 percent in 2007), were 8 percent lower in both the third quarter and first nine months of 2008. The reductions noted during the third quarter and first nine months of 2008 were the result of a combination of large programs nearing completion, program terminations, delays in program awards and government funding constraints. The reductions were partially offset by new program starts and increased scope on previously awarded contracts.
On February 15, 2008, BATC completed the sale of its shares in an Australian subsidiary for approximately $10.5 million, including cash sold of $1.8 million. After an adjustment for working capital items, the sale resulted in a pretax gain of $7.1 million ($4.4 million after tax).
Segment earnings were $18.4 million in the third quarter of 2008 compared to $18.3 million in 2007 and $63.1 million in the first nine months, which included the gain on BSG, compared to $53.5 million in 2007. Earnings were slightly higher in the third quarter and in the first nine months of 2008, excluding the gain on the sale of BSG, than in 2007 as a result of improved margins on contracts due to better program execution, improved contract mix and risk retirement on several fixed price programs, as well as a reserve release of $1.3 million in the second quarter due to the reduced exposure for estimated unallowable expenses.
Contracted backlog in the aerospace and technologies segment at September 28, 2008, was $672 million compared to a backlog of $774 million at December 31, 2007.
Additional Segment Information
For additional information on our segment operations, see the Business Segment Information in Note 3 accompanying the unaudited condensed consolidated financial statements included within Item 1 of this report.
Selling, General and Administrative
Selling, general and administrative (SG&A) expenses were $67.5 million in the third quarter of 2008 compared to $84.3 million for the same period in 2007 and $227.6 million in the first nine months of 2008 compared to $253.8 million in the first nine months of 2007. The decreases in SG&A expenses for the third quarter and first nine months of 2008 were due to lower general and administrative costs in the aerospace and technologies segment of approximately $7 million and $4 million, respectively; reduced incentive and deferred compensation stock plan costs of approximately $6 million and $13 million, respectively; favorable mark-to-market adjustments of derivatives by approximately $3 million and $2 million, respectively, and other miscellaneous net cost reductions. In the first nine months, lower research and development costs of $10 million in our aerospace and technologies segment and mortality gains of $3 million were partially offset by an increase in bad debt expense of $2 million.
Interest and Taxes
Consolidated interest expense was $33.1 million for the third quarter of 2008 compared to $36.2 million in the same period of 2007 and $104 million for the first nine months of 2008 compared to $112.2 million for the same period in 2007. The reduced expense in 2008 was primarily due to lower interest rates.
The effective income tax rate was 32 percent for the first nine months of 2008 compared to 26.5 percent for the same period in 2007. The lower tax rate in 2007 was primarily the result of a tax benefit recorded at the marginal rate on the legal settlement of a customer claim and net tax benefit adjustments of $17.2 . . .
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