Owens-Illinois shows cash flow improvement, debt reduction progress, despite loss

By Paul Deckelman

New York, Feb. 2 - Owens-Illinois Inc. dove deeply into the red in the fourth quarter, versus a year-ago profit, although the primary reason for the slide was a series of large, non-cash charges. Those charges were taken as the Toledo, Ohio-based maker of glass and plastic containers was turning itself around "financially and culturally," company chairman and chief executive officer Steven R. McCracken said on a conference call Thursday, following the Wednesday evening release of the numbers.

And McCracken and chief financial officer Edward C. White lauded the company's performance in boosting free cash flow - even if it came at the expense of earnings - and using that cash to sharply cut its debt.

"We delivered cash and paid down debt way beyond expectations," McCracken declared.

"We could have made some decisions in December," when the company idled much of its production capacity to bring inventory supply more into line with demand, "that would have made the EPS [earnings per share] just fine, we would have still executed on cash," the CEO said. "But we decided to bias ourselves toward cash, and as the year-end numbers came rolling in, and we were looking at the cash numbers, I can tell you - there were 'high-fives' in Toledo."

Owens-Illinois - the world's largest maker of glass containers, and a major manufacturer of plastic containers as well - reported a net loss for the 2005 fourth quarter ended Dec. 31 of $881.9 million, or $5.86 per share, versus a year-ago profit of $21.7 million, or 11 cents per share. Its net loss for continuing operations for the most recent quarter was identical to the overall net loss figures, while it showed a year-ago net loss from continuing operations of $32.7 million, or 25 cents per share.

The major driver behind the huge net loss in the just-concluded quarter, however, was non-cash charges against earnings totaling $935.6 million. The company took a pre-tax charge of $135 million - $86 million after-taxes - to reflect an increase in the reserve it maintains for dealing with asbestos claims litigation. It took a $494 million goodwill impairment connected with its Asia-Pacific glass containers business, and recorded a $306.6 million valuation allowance against its U.S. deferred tax assets.

On a continuing operations basis, not including the special items, the company showed a profit of $10.5 million, or 3 cents per share, although that was down from $42.1 million, or 24 cents per share, a year earlier.

But management, far from being displeased, was very satisfied with the results, seeing them as evidence that its turnaround efforts are working.

"Two-thousand and five was quite a ride for us," McCracken asserted, "and the fourth quarter was no exception. At the end of this ride though, we're feeling pretty good.

"I think to no one's surprise at this time, we have been unable to fully offset the inflationary headwinds in '05, not to mention for the fourth quarter. But we feel we have demonstrated, to ourselves, and increasingly to you [the analyst community] that we can indeed execute against our primary strategies and our core priorities, with positive results - and not just for today, but in a sustainable way," McCracken added.

"Had we maintained production at a slightly higher level in Q4, we would have improved EPS and still did well on cash. But we maintained our heavy bias for cash, and as a result, we got the results that we did," he said.

Liquidity a focus

A key priority for the company was increasing its liquidity and in turn improving its leverage picture.

"The cash story in the fourth quarter and the full year demonstrates our progress toward one of our six core priorities," CFO White said on the conference call - "improving liquidity and reducing leverage."

"Cash in the [fourth] quarter continued the strong year-over-year improvement seen in this year's third quarter," White told the analysts. Free cash flow in the quarter was $146.2 million - a net change of $151.8 million from a year earlier, when the company showed negative free cash flow - and totaled $99.7 million for all of 2005. After a rocky decade from the early 1990s to the early 2000s, during which time free cash flow was mostly on the downtrend year over year, it went up in 2004 and again in 2005, cumulatively totaling $273 million over those two years, the CFO said.

Consolidated debt lower

That, he said, allowed the company to bring its consolidated debt level down to its lowest point since 1998, the year Owens-Illinois acquired BTR Packaging, the worldwide glass and plastics packaging business of BTR plc. That debt-funded acquisition shot the consolidated debt level up from somewhat more than $3 billion in 1997 to nearly $6 billion in 1998 and afterward.

Owens-Illinois' own debt stood at just over $5 billion in 2005; even with the addition to its balance sheet of another $191.8 million of debt from the accounts receivable securitization program of the former BSN Glasspack SA - acquired by Owens-Illinois in 2004 - the consolidated debt figure stood at $5.297 billion as of Dec. 31, down from $5.3604 billion as of Dec. 31, 2004.

The company had $298.5 million of cash and short-term investments on hand as of Dec. 31, down a bit from $305.5 million a year earlier. Not counting the $191.8 million of BSN Glasspack receivables securitization debt - which was merged into the new Owens-Illinois Europe accounts receivables program in December, its debt included on the main balance sheet for the first time - the company's net debt (i.e., consolidated debt minus cash and short-term investments) stood at $4.8067 billion as of Dec. 31, a $248.2 million reduction from the 2004 year-end net debt of $5.0549 billion.

There was a $173.2 million decrease in net debt during the fourth quarter.

Including the $191.8 million of European receivables debt, Owens-Illinois' year-end net debt was $4.9985 billion, still down $56.4 million from a year earlier.

During the question-and-answer portion of the conference call, an analyst, without naming names, mentioned that Owens-Illinois had "a competitor that is in the bankruptcy process and [is] coming out" - an apparent reference to Tampa, Fla.-based Anchor Glass Container Corp., which entered Chapter 11 in 2005, for a second time in three years. He inquired whether the Ohio company might be interested in acquiring some or even all of its restructuring rival's assets.

McCracken answered that "our strategy is really one of consolidation in the established markets and growth in assets and market space in the developing markets," and added that "as the market-share leader, we've got to take a strategic interest in the disposition of this competitor." However, when the analyst asked whether Owens-Illinois might be open to debt financing any possible acquisition, the CEO declined comment, other than to say that his company would be "looking at all of our options from a strategic standpoint both from the market-base and asset standpoint, as well as our financial structure."

White said that by reducing working capital as a percentage of sales even as sales were increasing, by maintaining a disciplined stance on capital expenditures, and by whittling down its asbestos-related cash payments, Owens-Illinois was able to improve free-cash flow enough - and use that cash to reduce debt - so the company was able to bring its ratio of debt to EBITDA down to 3.82 to 1 at the end of 2005 from 4.13 to 1 at the end of 2004.

Interest expense shrinks

Owens-Illinois had fourth-quarter interest expense of $118.3 million, down from $150.5 million a year earlier, although it should be noted that the previous year's interest figure included $30.8 million for the write off of unamortized finance fees related to the company's early extinguishment of more than $1 billion of debt in 2004, using the proceeds from the company's divestiture that year of its blow-molded plastic container business, as well as repurchase premiums related to the November 2004 refinancing of several debt obligations.

Excluding these refinancing charges, interest expense in the fourth quarter of 2004 was $119.7 million. In the latest period, the company's interest expenses fell by $4.4 million due to lower interest rates on its fixed-rate debt, although this was largely offset by a $3.8 million increase in interest expenses due to higher rates on the variable-rate portion of its debt, in line with generally rising interest rates.

White and McCracken also talked about Owens-Illinois' asbestos liability situation; the CFO mentioned that the company is "one of the original asbestos defendants, with our litigation histories beginning in the early 1980s." He noted that after a series of asbestos-related bankruptcies among other companies - including former Owens-Illinois joint venture subsidiary Owens Corning - "our bank credit agreement and the overall debt structure became more complicated."

Although both companies have headquarters less than a mile from one another in Toledo and have similar names, no formal connection between Owens-Illinois and Owens Corning exists any longer. Owens-Illinois and former joint venture partner Corning Glass (now Corning Inc.), which jointly founded Owens Corning in 1935, spun off a large chunk of the joint venture to the stockholding public in 1952, and within a few years, both parents sold their remaining shares.

Owens-Illinois maintains that it thus left the asbestos business in 1958, and contends that a "significant number" of the cases which have been filed against it either involve exposure to asbestos after 1958, "for which the company takes the position that it has no liability," or are subject to dismissal because "they were filed in improper forums."

Asbestos lawsuits declining

As of Dec. 31, the number of pending asbestos-related lawsuits and claims was about 32,000, down from about 35,000 a year earlier. New filings during the quarter were 56% lower than the prior year quarter. The company's asbestos-related cash payments in the 2005 fourth quarter were $35.9 million, down 9.8% from the $39.8 million in the fourth quarter of 2004.

The company said it anticipates that cash flows from operations and other sources "will be sufficient to meet its asbestos-related obligations on a short-term and long-term basis."

Deferred amounts payable totaled some $91 million as of the end of 2005, virtually unchanged from the amount a year earlier. Asbestos cash payments for the full year 2005 were $171.1 million, down 10% from $190.1 million for the full year 2004. White said that was the lowest level of annual asbestos-related spending since 1999.

"Since 2001, year-on-year [asbestos-related] cash payments have been declining between 5% and 10% each year," the CFO said, "and we expect this trend to continue into the foreseeable future."

Just in case, though, the company took the pre-tax charge of $135 million to increase its reserve for future asbestos-related costs.

White said that each year, Owens-Illinois conducts a comprehensive review of its potential asbestos liabilities and costs, making an estimate of claims that will be filed in the future as it figures out the size of the charge it will take.

"We are encouraged by the decline that we took in the 2005 charge, which was 11.5% lower than the charge we took in 2004." He said the trend "is moving in the right direction, and is consistent with the data points on claims and cash spending."

As of the end of 2005, the company's total asbestos-related reserve balance was $730 million, down from $766 million at the end of 2004.

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