Ball 10-K 2007
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
( X ) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2006
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________________ to ________________
Commission File Number 1-7349
State of Indiana 35-0160610
10 Longs Peak Drive, P.O. Box 5000
Broomfield, Colorado 80021-2510
Registrant’s telephone number, including area code: (303) 469-3131
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES [X] NO [ ]
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES [ ] NO [X]
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). YES [ ] NO [X]
The aggregate market value of voting stock held by non-affiliates of the registrant was $3,873 million based upon the closing market price and common shares outstanding as of July 2, 2006.
Number of shares outstanding as of the latest practicable date.
DOCUMENTS INCORPORATED BY REFERENCE
1. Proxy statement to be filed with the Commission within 120 days after December 31, 2006, to the extent indicated in Part III.
Item 1. Business
Ball Corporation was organized in 1880 and incorporated in Indiana in 1922. Its principal executive offices are located at 10 Longs Peak Drive, Broomfield, Colorado 80021-2510. The terms "Ball," "the company," "we" and "our" as used herein refer to Ball Corporation and its consolidated subsidiaries.
Ball is a manufacturer of metal and plastic packaging, primarily for beverages, foods and household products, and a supplier of aerospace and other technologies and services to government and commercial customers.
Information Pertaining to the Business of the Company
The company has five reportable segments organized along a combination of product lines and geographic areas: (1) metal beverage packaging, Americas, (2) metal beverage packaging, Europe/Asia, (3) metal food and household products packaging, Americas, (4) plastic packaging, Americas, and (5) aerospace and technologies. Prior periods required to be shown in this Annual Report on Form 10-K (Annual Report) have been conformed to the current presentation.
A substantial part of our North American and international packaging sales are made directly to companies in packaged beverage and food businesses, including SABMiller and bottlers of Pepsi-Cola and Coca-Cola branded beverages and their affiliates that utilize consolidated purchasing groups. Sales to SABMiller plc, PepsiCo, Inc., and Coca-Cola Enterprises represented 11 percent, 9 percent and 9 percent of Ball’s consolidated net sales, respectively, for the year ended December 31, 2006. Additional details about sales to major customers are included in Note 2 to the consolidated financial statements, which can be found in Item 8 of this Annual Report (“Financial Statements and Supplementary Data”).
North American Packaging Segments
Our principal businesses in North America are the manufacture and sale of aluminum, steel, polyethylene terephthalate (PET) and polypropylene containers, primarily for beverages, foods and household products. Our packaging products are sold in highly competitive markets, primarily based on quality, service and price. The North American packaging business is capital intensive, requiring significant investment in machinery and equipment. Profitability is sensitive to selling prices, production volumes, labor, transportation, utility and warehousing costs, as well as the availability and price of raw materials, such as aluminum, steel, plastic resin and other direct materials. These raw materials are generally available from several sources, and we have secured what we consider to be adequate supplies and are not experiencing any shortages. We believe we have limited our exposure related to changes in the costs of aluminum, steel and plastic resin as a result of (1) the inclusion of provisions in most aluminum container sales contracts to pass through aluminum cost changes, as well as the use of derivative instruments, (2) the inclusion of provisions in certain steel container sales contracts to pass through steel cost changes and the existence of certain other steel container sales contracts that incorporate annually negotiated metal costs and (3) the inclusion of provisions in substantially all plastic container sales contracts to pass through resin cost changes. In 2006 we were able to pass through the majority of steel cost increases levied by producers, and we continually attempt to reduce manufacturing and other material costs as much as possible. While raw materials and energy sources, such as natural gas and electricity, may from time to time be in short supply or unavailable due to external factors, and the pass through of steel costs to our customers may be limited in some instances, we cannot predict the timing or effects, if any, of such occurrences on future operations.
Research and development (R&D) efforts in the North American packaging segments are primarily directed toward packaging innovation, specifically the development of new sizes and types of metal and plastic beverage, food and household product containers, as well as new uses for the current containers. Other research and development efforts in these segments seek to improve manufacturing efficiencies. Our North American packaging R&D activities are conducted in the Ball Technology and Innovation Center (BTIC) located in Westminster, Colorado, including the relocated R&D activities relating to the plastic bottle assets acquired March 28, 2006, from Alcan Packaging.
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Metal Beverage Packaging, Americas
Metal beverage packaging, Americas, represents Ball’s largest segment, accounting for 39 percent of consolidated net sales in 2006. Decorated two-piece aluminum beverage cans are produced at 16 manufacturing facilities in the U.S. and one each in Canada and Puerto Rico. Can ends are produced within three of the U.S. facilities, as well as in a fourth facility that manufactures only ends. Metal beverage containers are primarily sold under multi-year supply contracts to fillers of carbonated soft drinks, beer, energy drinks and other beverages. Sales volumes of metal beverage containers in North America tend to be highest during the period from April through September.
Through Rocky Mountain Metal Container, LLC, a 50/50 joint venture, which is accounted for as an equity investment, Ball and Coors Brewing Company (Coors), a wholly owned subsidiary of Molson Coors Brewing Company, operate beverage can and end manufacturing facilities in Golden, Colorado. The joint venture supplies Coors with beverage cans and ends for its Golden, Colorado, brewery and supplies ends to its Shenandoah, Virginia, filling location. Ball receives management fees and technology licensing fees under agreements with the joint venture. In addition to beverage containers supplied to Coors from the joint venture, Ball supplies, from its own facilities, substantially all of Coors’ metal container requirements for its Shenandoah, Virginia, filling location, as well as other sizes of containers not manufactured by the joint venture.
We also participate in a 50/50 joint venture in Brazil that manufactures aluminum cans and ends and is accounted for as an equity investment.
Based on publicly available industry information, we estimate that our North American metal beverage container shipments in 2006 of approximately 33 billion cans were approximately 32 percent of total U.S. and Canadian shipments of metal beverage containers. Three producers manufacture substantially all of the remaining metal beverage containers. Two of these producers and three other independent producers also manufacture metal beverage containers in Mexico. Available information indicates that North American metal beverage container shipments have been relatively flat during the past several years. Although in 2006 the U.S. industry experienced a 2.3 percent growth in can shipments, it is difficult to predict whether this higher growth rate will become a trend.
Beverage container production capacity in the U.S., Canada and Mexico exceeds demand. In order to more closely balance capacity and demand within our business, from time to time we consolidate our can and end manufacturing capacity into fewer, more efficient facilities. We also attempt to efficiently match capacity with the changes in customer demand for our packaging products. To that end, during 2005 Ball commenced a project to upgrade and streamline its North American beverage can end manufacturing capabilities, a project expected to result in productivity improvements and reduced manufacturing costs. In connection with these activities, the company recorded a pretax charge of $19.3 million ($11.7 million after tax) in the third quarter of 2005. We have installed the first three production modules in this multi-year project and the fourth and fifth modules are in the installation phase, and the project is expected to be fully completed in 2008. In connection with this project, the can end manufacturing operations at the Reidsville, North Carolina, plant were shut down during the fourth quarter of 2006.
The aluminum beverage container continues to compete aggressively with other packaging materials in the beer and carbonated soft drink industries. The glass bottle has shown resilience in the packaged beer industry, while carbonated soft drink and beer industry use of PET containers has grown. In Canada, metal beverage containers have captured significantly lower percentages of the packaged beverage industry than in the U.S., particularly in the packaged beer industry.
Metal Food & Household Products Packaging, Americas
Metal food and household products packaging, Americas, accounted for 18 percent of consolidated net sales in 2006. The two major product lines in this segment are steel food and aerosol containers. Aerosol containers were added with the acquisition of U.S. Can Corporation (U.S. Can) on March 27, 2006 (discussed below). Ball produces two-piece and three-piece steel food containers and ends for packaging vegetables, fruit, soups, meat, seafood, nutritional products, pet food and other products. These containers and ends are manufactured in 9 plants in the U.S. and Canada and sold primarily to food processors in North America. Sales volumes of metal food containers in North America tend to be highest from June through October as a result of seasonal vegetable and salmon packs. We estimate our 2006 shipments of more than 6 billion steel food containers to be approximately 20 percent of total U.S. and Canadian metal food container shipments.
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On March 27, 2006, Ball Corporation acquired all the issued and outstanding shares of U.S. Can for consideration of 444,756 Ball common shares, together with the repayment of $598 million of existing U.S. Can debt, including $27 million of bond redemption premiums and fees. The acquired business manufactures and sells aerosol cans, paint cans, plastic containers and custom and specialty containers in 10 plants in the U.S. and is the largest manufacturer of aerosol cans in North America. In addition, the company manufactures and sells aerosol cans in two plants in Argentina. The acquired operations employ 2,300 people and have annual sales of approximately $600 million. The acquisition has been accounted for as a purchase, and, accordingly, its results have been included in our consolidated financial statements in the metal food and household products packaging, Americas, segment from March 27, 2006. We estimate the U.S. Can aerosol business accounts for approximately 53 percent of total annual U.S. and Canadian steel aerosol shipments.
In December 2006, as part of a product realignment plan, the company closed a leased facility in Alliance, Ohio, which was one of the 10 manufacturing locations acquired from U.S. Can, and a metal food can manufacturing plant in Burlington, Ontario, which was part of the metal food can operations prior to the U.S. Can acquisition. The closure of the Alliance plant was treated as an opening balance sheet item related to the acquisition. A pretax charge of $33.6 million ($27.4 million after tax) was recorded in the fourth quarter in respect of the Burlington plant closure. As part of the realignment plan, responsibility for the U.S. Can plastic container business was transferred to the company’s plastic packaging, Americas, segment effective January 1, 2007.
Also in 2006, a pretax charge of $1.4 million ($0.9 million after tax) was recorded to shut down a metal food can production line in the Whitby, Ontario, plant. Production from the line has ceased and other shut down activities are expected to be completed by the end of the first quarter of 2007.
In 2005 the company recorded a pretax charge of $11.2 million ($7.5 million after tax) related to a work force reduction in the Burlington plant and to close a food can plant in Quebec. The Quebec plant was closed and ceased operations in the third quarter of 2005 and the land and building were sold.
Competitors in the metal food container product line include two national and a small number of regional suppliers and self manufacturers. Several producers in Mexico also manufacture steel food containers. Competition in the U.S. steel aerosol can market primarily includes two national suppliers. Steel containers also compete with other packaging materials in the food and household products industry including glass, aluminum, plastic, paper and the stand-up pouch. As a result, demand for this product line is dependent on product innovation and cost reduction. Service, quality and price are among the key competitive factors.
Plastic Packaging, Americas
Plastic packaging, Americas, accounted for 10 percent of Ball’s consolidated net sales in 2006. Demand for containers made of PET and polypropylene has increased in the beverage and food markets, with improved barrier technologies and other advances. This growth in demand is expected to continue. While PET and polypropylene beverage containers compete against metal, glass and cardboard, the historical increase in the sales of PET containers has come primarily at the expense of glass containers and through new market introductions. We estimate our 2006 shipments of more than 5.7 billion plastic containers to be approximately 9 percent of total U.S. and Canadian PET container shipments. In addition, this segment produced more than 640 million food and specialty containers during 2006 as a result of the Alcan Packaging (Alcan) acquisition (discussed below). The company operates seven plastic container manufacturing facilities in the U.S. and one in Canada.
On March 28, 2006, Ball Corporation acquired certain North American plastic container net assets from Alcan Packaging for a total cash consideration of $185 million. Ball acquired plastic container manufacturing plants in Batavia, Illinois; Bellevue, Ohio; and Brampton, Ontario; as well as certain equipment and other assets at an Alcan research facility in Neenah, Wisconsin, and at a plant in Newark, California. Subsequent to the acquisition, the R&D activities were relocated from Neenah to the BTIC in Westminster, Colorado, and plastic bottle production at the Newark, California, plant was terminated. The costs of these activities were treated as opening balance sheet items. The acquired business primarily manufactures and sells barrier polypropylene plastic bottles used in food packaging and, to a lesser extent, manufactures and sells barrier PET plastic bottles used for beverages and foods. The acquired business employs approximately 470 people and has annual sales of approximately $150 million. The acquisition has been accounted for as a purchase, and, accordingly, its results have been included in our consolidated financial statements in the plastic packaging, Americas, segment from March 28, 2006.
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Competition in the PET plastic container industry includes several national and regional suppliers and self manufacturers, while Ball is one of three major competitors in the polypropylene container industry. Service, quality and price are important competitive factors. The ability to produce customized, differentiated plastic containers is also a key competitive factor.
Most of Ball’s PET containers are sold under long-term contracts to suppliers of bottled water and carbonated soft drinks, including bottlers of Pepsi-Cola branded beverages and their affiliates that utilize consolidated purchasing groups. Most of our polypropylene containers are also sold under long-term contracts, primarily to food packaging companies. Plastic beer containers are being produced for several of our customers, and we are manufacturing plastic containers for the single serve juice and wine markets. Our line of Heat-Tek(TM) PET plastic bottles for hot-filled beverages, such as sports drinks and juices, includes sizes from 8 ounces to 64 ounces.
Metal Beverage Packaging, Europe/Asia
The metal beverage packaging, Europe/Asia, segment, which accounted for 23 percent of Ball’s consolidated net sales in 2006, consists of 10 beverage can plants and two beverage can end plants in Europe, as well as operations in the People’s Republic of China (PRC). Of the 12 European plants, four are located in Germany, three in the United Kingdom, two in France and one each in the Netherlands, Poland and Serbia. The European plants produced approximately 13 billion cans in 2006, with approximately 60 percent of those being produced from aluminum and 40 percent from steel. Six of the can plants use aluminum and four use steel.
Ball Packaging Europe is the second largest metal beverage container producer in Europe, with an estimated 29 percent of European shipments, and produces two-piece beverage cans and can ends for producers of beer, carbonated soft drinks, mineral water, fruit juices, energy drinks and other beverages. Ball Packaging Europe is the largest metal beverage container manufacturer in Germany, France and the Benelux countries and the second largest metal beverage container manufacturer in the United Kingdom and Poland. In 2005 Ball completed the construction of an aluminum beverage can manufacturing plant in Belgrade, Serbia, to serve the growing demand for beverage cans in southern and eastern Europe.
On April 1, 2006, a fire in the company’s Hassloch, Germany, plant damaged the majority of the plant’s building and machinery and equipment. Property insurance proceeds will largely cover equipment replacement cost and clean-up costs, and business interruption insurance proceeds generally cover lost volumes and other costs. In June 2006 the company announced its intention to rebuild the Hassloch plant with two steel lines and to add an aluminum line in its Hermsdorf, Germany, plant to replace the lost volume. All three lines are expected to be operational during the second quarter of 2007.
As in North America, the metal beverage container competes aggressively with other packaging materials used by the European beer and carbonated soft drink industries. The glass bottle is heavily utilized in the packaged beer industry, while the PET container is increasingly utilized in the carbonated soft drink, juice and mineral water industries.
The European beverage can business is capital intensive, requiring significant investments in machinery and equipment. Profitability is sensitive to selling prices, foreign exchange rates, transportation costs, production volumes, labor and the costs and availability of certain raw materials, such as aluminum and steel. The European aluminum and steel industries are highly consolidated with three steel suppliers and three aluminum suppliers providing 95 percent of European requirements. Raw material supply contracts are generally for a period of one year, although Ball Packaging Europe has negotiated some longer term agreements. Aluminum is purchased primarily in U.S. dollars while the functional currencies of Ball Packaging Europe and its subsidiaries are non-U.S. dollars. This inherently results in a foreign exchange rate risk, which the company minimizes through the use of derivative contracts. In addition, purchase and sales contracts include fixed price, floating and pass-through pricing arrangements.
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R&D efforts in Europe are directed toward the development of new sizes and types of metal containers, as well as new uses for the current containers. Other research and development objectives in this segment include improving manufacturing efficiencies. The European R&D activities are conducted in a technical center located in Bonn, Germany.
Through Ball Asia Pacific Limited, we are one of the largest beverage can manufacturers in the PRC and believe that our facilities are among the most modern in that country. Capacity grew rapidly in the PRC in the late 1990s, resulting in a supply/demand imbalance to which we responded by rationalizing capacity. Demand growth has resumed and projected annual growth is expected to be in the 5 to 10 percent range in the near term. Ball is undertaking selected capacity increases in its existing facilities in order to participate in the projected growth. Our operations include the manufacture of aluminum cans and ends in three plants in the PRC located in the north, central and south regions. We also manufacture and sell high-density plastic containers in two PRC plants. In addition, we participate in two joint ventures that manufacture aluminum cans and ends in the PRC.
In the fourth quarter of 2006, we acquired the minority interest ownership in the high-density plastic (HDP) container business for $4.6 million in cash and signed a long-term supply contract with the former minority owner. This business operates two HDP container plants in the PRC.
For more information on Ball’s international operations, see Item 2, “Properties,” and Exhibit 21, “Subsidiary List.”
Aerospace and Technologies
The aerospace and technologies segment, which accounted for 10 percent of consolidated net sales in 2006, includes national defense solutions, advanced technologies and products, civil space systems and operational space businesses. The segment develops spacecraft, sensors and instruments, radio frequency systems and other advanced technologies for the civil, commercial and national security aerospace markets.
The majority of the aerospace and technologies business involves work under contracts, generally from one to five years in duration, as a prime contractor or subcontractor for the National Aeronautics and Space Administration (NASA), the U.S. Department of Defense (DoD) and other U.S. government agencies. Contracts funded by the various agencies of the federal government represented 90 percent of segment sales in 2006. Geopolitical events and executive and legislative branch priorities have yielded considerable growth opportunities in areas matching our core capabilities. However, there is strong competition for new business.
The civil space systems, defense solutions and operational space businesses include hardware, software and services sold primarily to U.S. customers, with emphasis on space science and exploration, environmental and Earth sciences, and defense and intelligence applications. Major contractual activities frequently involve the design, manufacture and testing of satellites, remote sensors and ground station control hardware and software, as well as related services such as launch vehicle integration and satellite operations.
Other hardware activities include: target identification, warning and attitude control systems and components; cryogenic systems for reactant storage, and sensor cooling devices using either closed-cycle mechanical refrigerators or open-cycle solid and liquid cryogens; star trackers, which are general-purpose stellar attitude sensors; and fast-steering mirrors. Additionally, the aerospace and technologies segment provides diversified technical services and products to government agencies, prime contractors and commercial organizations for a broad range of information warfare, electronic warfare, avionics, intelligence, training and space systems needs.
Backlog in the aerospace and technologies segment was $886 million and $761 million at December 31, 2006 and 2005, respectively, and consists of the aggregate contract value of firm orders, excluding amounts previously recognized as revenue. The 2006 backlog includes $528 million expected to be recognized in revenues during 2007, with the remainder expected to be recognized in revenues thereafter. Unfunded amounts included in backlog for certain firm government orders which are subject to annual funding were $492 million and $500 million at December 31, 2006 and 2005, respectively. Year-to-year comparisons of backlog are not necessarily indicative of the trend of future operations.
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The company’s aerospace and technologies segment has contracts with the U.S. government or its contractors which have standard termination provisions. The government retains the right to terminate contracts at its convenience. However, if contracts are terminated in this manner, Ball is entitled to reimbursement for allowable costs and profits on authorized work performed through the date of termination. U.S. government contracts are also subject to reduction or modification in the event of changes in government requirements or budgetary constraints.
In the opinion of the company, none of its active patents is essential to the successful operation of its business as a whole.
Research and Development
Note 19, "Research and Development," in the consolidated financial statements within Item 8 of this report, contains information on company research and development activity. Additional information is also included in Item 2, “Properties.”
Aluminum, steel and plastic containers are recyclable, and significant amounts of used containers are being diverted from the solid waste stream and recycled. Using the most recent data available, in 2005 approximately 52 percent of aluminum containers, 63 percent of steel containers and 23 percent of the PET containers sold in the U.S. were recycled. Recycling rates vary throughout Europe, but generally average 60 percent for aluminum and steel containers, which exceeds the European Union’s goal of 50 percent recycling for metals. Due in part to the intrinsic value of aluminum and steel, metal packaging recycling rates in the U.S. and Europe compare favorably to those of other packaging materials.
Compliance with federal, state and local laws relating to protection of the environment has not had a material, adverse effect upon the capital expenditures, earnings or competitive position of the company. As more fully described under Item 3, “Legal Proceedings,” the U.S. Environmental Protection Agency and various state environmental agencies have designated the company as a potentially responsible party, along with numerous other companies, for the cleanup of several hazardous waste sites. However, the company’s information at this time indicates that these matters will not have a material adverse effect upon the liquidity, results of operations or financial condition of the company.
Legislation which would prohibit, tax or restrict the sale or use of certain types of containers, and would require diversion of solid wastes such as packaging materials from disposal in landfills, has been or may be introduced anywhere we operate. While container legislation has been adopted in some jurisdictions, similar legislation has been defeated in public referenda and legislative bodies in numerous others. The company anticipates that continuing efforts will be made to consider and adopt such legislation in many jurisdictions in the future. If such legislation were widely adopted, it potentially could have a material adverse effect on the business of the company, including its liquidity, results of operations or financial condition. This legislation could also have a material adverse effect on the container manufacturing industry generally, in view of the company’s substantial global sales and investment in metal and PET container manufacturing. However, the packages we produce are widely used and perform well in most jurisdictions that have deposit systems.
At the end of December 2006, the company employed approximately 15,500 people worldwide, including 11,200 employees in the U.S. and 4,300 in other countries. There are an additional 1,000 people employed in unconsolidated joint ventures in which Ball participates. Approximately one-third of Ball's North American packaging plant employees are unionized and most of our European plant employees are union workers. Collective bargaining agreements with various unions in the U.S. have terms of three to five years and those in Europe have terms of one to two years. The agreements expire at regular intervals and are customarily renewed in the ordinary course after bargaining between union and company representatives. The company believes that its employee relations are good and that its training, education and retention practices assist in enhancing employee satisfaction levels.
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Where to Find More Information
Ball Corporation is subject to the reporting and other information requirements of the Securities Exchange Act of 1934, as amended (Exchange Act). Reports and other information filed with the Securities and Exchange Commission (SEC) pursuant to the Exchange Act may be inspected and copied at the public reference facility maintained by the SEC in Washington, D.C. The SEC maintains a website at www.sec.gov containing our reports, proxy materials, information statements and other items.
The company also maintains a website at www.ball.com on which it provides a link to access Ball’s SEC reports free of charge.
The company has established written Ball Corporation Corporate Governance Guidelines; a Ball Corporation Executive Officers and Board of Directors Business Ethics Statement (Ethics Statement); a Business Ethics booklet; and Ball Corporation Audit Committee, Nominating/Corporate Governance Committee, Human Resources Committee and Finance Committee charters. These documents are set forth on the company’s website at www.ball.com under the section “Investors,” under the subsection “Financial Information,” and under the link “Corporate Governance.” A copy may also be obtained upon request from the company’s corporate secretary.
The company intends to post on its website the nature of any amendments to the company’s codes of ethics that apply to executive officers and directors, including the chief executive officer, chief financial officer or controller, and the nature of any waiver or implied waiver from any code of ethics granted by the company to any executive officer or director. These postings will appear on the company’s website at www.ball.com under the section “Investors,” under the subsection “Financial Information,” and under the link “Corporate Governance” and will include a January 24, 2007, amendment to its Ethics Statement which sets out our policies and procedures for dealing with transactions with related persons now required to be disclosed as a result of recent statutory amendments.
Item 1A. Risk Factors
Any of the following risks could materially and adversely affect our business, financial condition or results of operations.
There can be no assurance that the U.S. Can and Alcan businesses, or any acquisition, will be successfully integrated into the acquiring company (see Note 3 to the consolidated financial statements within Item 8 of this report for details of the acquisitions).
While we have what we believe to be well designed integration plans, if we cannot successfully integrate U.S. Can’s and Alcan’s operations with those of Ball, we may experience material negative consequences to our business, financial condition or results of operations. The integration of companies that have previously been operated separately involves a number of risks, including, but not limited to:
Prior to the acquisitions, Ball, U.S. Can and Alcan operated as separate businesses. We may not be able to achieve potential synergies or maintain the levels of revenue, earnings or operating efficiency that each business had achieved or might achieve separately. The successful integration of U.S. Can’s and Alcan’s operations will depend on our ability to manage those operations, realize opportunities for revenue growth presented by strengthened product offerings and, to some degree, to eliminate redundant and excess costs.
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The loss of a key customer could have a significant negative impact on our sales.
While we have diversified our customer base, we do sell a majority of our packaging products to relatively few major beverage, packaged food and household product companies, which operate in North America, South America, Europe and Asia.
Although approximately 70 percent of our customer contracts are long-term, these contracts are terminable under certain circumstances, such as our failure to meet quality or volume requirements. Because we depend on relatively few major customers, our business, financial condition or results of operations could be adversely affected by the loss of any of these customers, a reduction in the purchasing levels of these customers, a strike or work stoppage by a significant number of these customers' employees or an adverse change in the terms of the supply agreements with these customers.
The primary customers for our aerospace segment are U.S. government agencies or their prime contractors. These sales represented approximately 9 percent of Ball's consolidated 2006 net sales. Our contracts with these customers are subject to, among other things, the following risks:
We face competitive risks from many sources that may negatively impact our profitability.
Competition within the packaging industry is intense. Increases in productivity, combined with surplus capacity in the industry, have maintained competitive pricing pressures. The principal methods of competition in the general packaging industry are price, service and quality. Some of our competitors may have greater financial, technical and marketing resources. Our current or potential competitors may offer products at a lower price or products that are deemed superior to ours.
We are subject to competition from alternative products, which could result in lower profits and reduced cash flows.
Our packaging products are subject to significant competition from substitute products, particularly plastic carbonated soft drink bottles made from PET, single serve beer bottles and containers made of glass, cardboard or other materials. Competition from plastic carbonated soft drink bottles is particularly intense in the United States and the United Kingdom. There can be no assurance that our products will successfully compete against alternative products, which could result in a reduction in our profits or cash flow.
We have a narrow product range and our business would suffer if usage of our products decreased.
For the 12 months ended December 31, 2006, 62 percent of our consolidated net sales were from the sale of metal beverage cans, and we expect to derive a significant portion of our future revenues from the sale of metal beverage cans. We sell no PET bottles in Europe. Our business would suffer if the use of metal beverage cans decreased. Accordingly, broad acceptance by consumers of aluminum and steel cans for a wide variety of beverages is critical to our future success. If demand for glass and PET bottles increases relative to cans, or the demand for aluminum and steel cans does not develop as expected, our business, financial condition or results of operations could be materially adversely affected.
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Our business, financial condition and results of operations are subject to risks resulting from increased international operations.
We derived 23 percent of our consolidated net sales from outside of North and South America in the year ended December 31, 2006. This sizeable scope of international operations may lead to more volatile financial results and make it more difficult for us to manage our business. Reasons for this include, but are not limited to, the following:
Any of these factors could materially adversely affect our business, financial condition or results of operations.
We are exposed to exchange rate fluctuations.
For the 12 months ended December 31, 2006, 77 percent of our consolidated net sales were attributable to operations with the U.S. dollar as their functional currency, 11 percent with the euro as the functional currency and 12 percent were attributable to operations having functional currencies other than the U.S. dollar or the euro.
Our reporting currency is the U.S. dollar. Historically, Ball's foreign operations, including assets and liabilities and revenues and expenses, have been denominated in various currencies other than the U.S. dollar, and we expect that our foreign operations will continue to be so denominated. As a result, the U.S. dollar value of Ball's foreign operations has varied, and will continue to vary, with exchange rate fluctuations. Ball has been, and is presently, primarily exposed to fluctuations in the exchange rate of the euro, British pound, Canadian dollar, Polish zloty, Chinese renminbi, Brazilian real, Argentine peso and Serbian dinar.
A decrease in the value of any of these currencies, especially the euro and the British pound, relative to the U.S. dollar could reduce our profits from foreign operations and the value of the net assets of our foreign operations when reported in U.S. dollars in our financial statements. This could have a material adverse effect on our business, financial condition or results of operations as reported in U.S. dollars.
In addition, fluctuations in currencies relative to currencies in which the earnings are generated may make it more difficult to perform period-to-period comparisons of our reported results of operations. For purposes of accounting, the assets and liabilities of our foreign operations, where the local currency is the functional currency, are translated using period-end exchange rates, and the revenues and expenses of our foreign operations are translated using average exchange rates during each period. Translation gains and losses are reported in accumulated other comprehensive loss as a component of shareholders' equity.
We actively manage our exposure to foreign currency fluctuations, particularly our exposure to fluctuations in the euro to U.S. dollar exchange rate, in order to mitigate the effect of foreign cash flow and reduce earnings volatility associated with foreign exchange rate changes. We primarily use forward contracts and options to manage our foreign currency exposures and, as a result, we experience gains and losses on these derivative positions offset, in part, by the impact of currency fluctuations on existing assets and liabilities. Our inability to properly manage our exposure to currency fluctuations could materially impact our results.
Our business, operating results and financial condition are subject to particular risks in certain regions of the world.
We may experience an operating loss in one or more regions of the world for one or more periods, which could have a material adverse effect on our business, operating results or financial condition. Moreover, overcapacity, which often leads to lower prices, exists in a number of regions, including North America, South America and Asia, and may persist even if demand grows. Our ability to manage such operational fluctuations and to maintain adequate long-term strategies in the face of such developments will be critical to our continued growth and profitability.
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If we fail to retain key management and personnel, we may be unable to implement our key objectives.
We believe that our future success depends in part on our experienced management team. Losing the services of key members of our management team could make it difficult for us to manage our business and meet our objectives.
Decreases in our ability to apply new technology and know-how may affect our competitiveness.
Our success depends in part on our ability to improve production processes and services. We must also introduce new products and services to meet changing customer needs. If we are unable to implement better production processes or to develop new products, we may not be able to remain competitive with other manufacturers. As a result, our business, financial condition or results of operations could be adversely affected.
Bad weather and climate changes may result in lower sales.
We manufacture packaging products primarily for beverages and foods. Unseasonably cool weather can reduce demand for certain beverages packaged in our containers. In addition, poor weather conditions or changes in climate that reduce crop yields of fruits and vegetables can adversely affect demand for our food containers, creating potentially adverse effects on our business. Natural or other catastrophes, such as earthquakes, hurricanes, fires and floods, could significantly damage or destroy one or more of our facilities, as well as those of our suppliers and customers, which could adversely affect our business, financial condition or results of operations.
We are vulnerable to fluctuations in the supply and price of raw materials.
We purchase aluminum, steel, plastic resin and other raw materials and packaging supplies from several sources. While all such materials are available from independent suppliers, raw materials are subject to fluctuations in price attributable to a number of factors, including general economic conditions, commodity price fluctuations (particularly aluminum on the London Metal Exchange), the demand by other industries for the same raw materials and the availability of complementary and substitute materials. Although we enter into commodities purchase agreements from time to time and use derivative instruments to hedge our risk, we cannot ensure that our current suppliers of raw materials will be able to supply us with sufficient quantities or at reasonable prices. Increases in raw material costs could have a material adverse effect on our business, financial condition or results of operations. Because our North American contracts often pass raw material costs directly on to the customer, increasing raw materials costs may not impact our near-term profitability but could decrease our sales volume over time. In Europe, our contracts do not typically allow us to pass on increased raw material costs and we regularly use derivative agreements to manage this risk. Our hedging procedures may be insufficient and our results could be materially impacted if materials costs increase.
Prolonged work stoppages at plants with union employees could jeopardize our financial position.
As of December 31, 2006, approximately a third of our employees in North America and most of our employees in Europe were covered by one or more collective bargaining agreements. These collective bargaining agreements have staggered expirations during the next three years. Although we consider our employee relations to be generally good, a prolonged work stoppage or strike at any facility with union employees could have a material adverse effect on our business, financial condition or results of operations. In addition, we cannot assure you that upon the expiration of existing collective bargaining agreements new agreements will be reached without union action or that any such new agreements will be on terms satisfactory to us.
Our business is subject to substantial environmental remediation and compliance costs.
Our operations are subject to federal, state and local laws and regulations relating to environmental hazards, such as emissions to air, discharges to water, the handling and disposal of hazardous and solid wastes and the cleanup of hazardous substances. The U.S. Environmental Protection Agency has designated us, along with numerous other companies, as a potentially responsible party for the cleanup of several hazardous waste sites. Based on available information, we do not believe that any costs incurred in connection with such sites will have a material adverse effect on our financial condition, results of operations, capital expenditures or competitive position.
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If we were required to write down all or part of our goodwill, our net earnings and net worth could be materially adversely affected.
We have $1,773.7 million of goodwill recorded on our consolidated balance sheet as of December 31, 2006. We are required to periodically determine if our goodwill has become impaired, in which case we would write down the impaired portion of our goodwill. If we were required to write down all or a significant part of our goodwill, our net earnings and net worth could be materially adversely affected.
If the investments in Ball's pension plans do not perform as expected, we may have to contribute additional amounts to the plans, which would otherwise be available to cover operating expenses.
Ball maintains noncontributory, defined benefit pension plans covering substantially all of its U.S. employees, which we fund based on certain actuarial assumptions. The plans' assets consist primarily of common stocks and fixed income securities. If the investments in the plans do not perform at expected levels, we will have to contribute additional funds to ensure that the plans will be able to pay out benefits as scheduled. Such an increase in funding could result in a decrease in our available cash flow and net earnings, and the recognition of such an increase could result in a reduction to our shareholders' equity.
Our significant debt could adversely affect our financial health and prevent us from fulfilling our obligations under the notes issued pursuant to our bond indentures.
We have a significant amount of debt. On December 31, 2006, we had total debt of $2,451.7 million. Our ratio of earnings to fixed charges as of that date was 3.6 times (see Exhibit 12 attached to this Annual Report). Our relatively high level of debt could have important consequences, including the following:
In addition, a substantial portion of our debt bears interest at variable rates. If market interest rates increase, variable-rate debt will create higher debt service requirements, which would adversely affect our cash flow. While we sometimes enter into agreements limiting our exposure, any such agreements may not offer complete protection from this risk.
We will require a significant amount of cash to service our debt. Our ability to generate cash depends on many factors beyond our control.
Our ability to make payments on and to refinance our debt, including the notes, and to fund planned capital expenditures and research and development efforts, will depend on our ability to generate cash in the future. This is subject to general economic, financial, competitive, legislative, regulatory and other factors that may be beyond our control.
Based on our current level of operations, we believe our cash flow from operations, available cash and available borrowings under our new credit facilities will be adequate to meet our future liquidity needs for the next several years, barring any unforeseen circumstances which are beyond our control.
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We cannot be certain that our business will generate sufficient cash flow from operations or that future borrowings will be available to us under our credit facilities or otherwise in an amount sufficient to enable us to pay our debt, including the notes, or to fund our other liquidity needs. We may need to refinance all or a portion of our debt, including the notes, on or before maturity. We cannot be sure that we will be able to refinance any of our debt, including our credit facilities and our senior notes, on commercially reasonable terms or at all.
Item 1B. Unresolved Staff Comments
There were no matters required to be reported under this item.
The company’s properties described below are well maintained, are considered adequate and are being utilized for their intended purposes.
Ball’s corporate headquarters and the aerospace and technologies segment offices are located in Broomfield, Colorado. The Colorado-based operations of the aerospace and technologies business occupy a variety of company-owned and leased facilities in Broomfield, Boulder and Westminster, which together aggregate 1.4 million square feet of office, laboratory, research and development, engineering and test and manufacturing space. Other aerospace and technologies operations carry on business in company-owned and leased facilities in Georgia, New Mexico, Ohio, Virginia, Washington, D.C., and Australia.
The offices of the company’s North American packaging operations are located in Westminster, Colorado, and the offices for the European packaging operations are located in Ratingen, Germany. Also located in Westminster is the Ball Technology and Innovation Center, which serves as a research and development facility for the North American metal packaging and plastic container operations. The European Technical Centre, which serves as a research and development facility for the European beverage can manufacturing operations, is located in Bonn, Germany.
Information regarding the approximate size of the manufacturing locations for significant packaging operations, which are owned or leased by the company, is set forth below. Facilities in the process of being shut down have been excluded from the list. Where certain locations include multiple facilities, the total approximate size for the location is noted. In addition to the facilities listed, the company leases other warehousing space.
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(a) Includes both metal beverage container and metal food container manufacturing operations.
(b) Currently under reconstruction after the plant was damaged by fire in April 2006. (Additional details are available in Note 5 within Item 8 of this Annual Report.)
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(a) Includes both metal beverage container and metal food container manufacturing operations.
(b) Will be included in plastic packaging, Americas, segment beginning in 2007.
In addition to the consolidated manufacturing facilities, the company has ownership interests of 50 percent or less in packaging affiliates located primarily in the U.S., PRC and Brazil.
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Item 3. Legal Proceedings
As previously reported, the U.S. Environmental Protection Agency (USEPA) considers the company a Potentially Responsible Party (PRP) with respect to the Lowry Landfill site located east of Denver, Colorado. On June 12, 1992, the company was served with a lawsuit filed by the City and County of Denver (Denver) and Waste Management of Colorado, Inc., seeking contributions from the company and approximately 38 other companies. The company filed its answer denying the allegations of the complaint. On July 8, 1992, the company was served with a third-party complaint filed by S.W. Shattuck Chemical Company, Inc., seeking contribution from the company and other companies for the costs associated with cleaning up the Lowry Landfill. The company denied the allegations of the complaints.
In July 1992 the company entered into a settlement and indemnification agreement with Chemical Waste Management, Inc., and Waste Management of Colorado, Inc. (collectively Waste Management) and Denver pursuant to which Waste Management and Denver dismissed their lawsuit against the company, and Waste Management agreed to defend, indemnify and hold harmless the company from claims and lawsuits brought by governmental agencies and other parties relating to actions seeking contributions or remedial costs from the company for the cleanup of the site. Several other companies, which are defendants in the above-referenced lawsuits, had already entered into the settlement and indemnification agreement with Waste Management and Denver. Waste Management, Inc., has agreed to guarantee the obligations for Chemical Waste Management, Inc., and Waste Management of Colorado, Inc. Waste Management and Denver may seek additional payments from the company if the response costs related to the site exceed $319 million. In 2003 Waste Management, Inc., indicated that the cost of the site might exceed $319 million in 2030, approximately three years before the projected completion of the project. The company might also be responsible for payments (based on 1992 dollars) for any additional wastes which may have been disposed of by the company at the site but which are identified after the execution of the settlement agreement. While remediating the site, contaminants were encountered which could add an additional cleanup cost of approximately $10 million. This additional cleanup cost could, in turn, add approximately $1 million to total site costs for the PRP group.
At this time, there are no Lowry Landfill actions in which the company is actively involved. Based on the information available to the company at this time, the company does not believe that this matter will have a material adverse effect upon the liquidity, results of operations or financial condition of the company.
The company previously reported that, on August 1, 1997, the USEPA sent notice of potential liability to 19 PRPs concerning past activities at one or more of the four Rocky Flats parcels (including land owned by Precision Chemicals now owned by Great Western Inorganics) at the Rocky Flats Industrial Park site (RFIP) located in Jefferson County, Colorado. The RFIP site also includes the American Ecological Recycling and Research Company (AERRCO) site and a site owned by Thoro Products Company. Based upon sampling at the site in 1996, the USEPA determined that additional site work would be required to determine the extent of contamination and the possible cleanup of the site. In 1996 the USEPA requested that the PRPs perform certain site work. On December 19, 1997, the USEPA issued an Administrative Order on Consent (AOC) to conduct engineering estimates and cost analyses. The company has funded approximately $70,000 toward these costs. The PRPs have negotiated an agreement and the company contributed $5,000 as an initial group contribution. The company has agreed to pay 12 percent of the costs of cleanup at the AERRCO site and a percentage of the cleanup costs on the Thoro site. On January 8, 2003, and October 9, 2003, the company made additional payments of $97,200 each (total $194,400) toward the cost of cleanup. The company paid $35,355 in 2004 toward the cleanup. An air sparge and soil vapor extraction system was installed at a total cost of $1.1 million and was placed in operation in May 2005. Based on the information available to the company at this time, the company does not believe that this matter will have a material adverse effect upon the liquidity, results of operations or financial condition of the company.
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As previously reported, in October 2001 representatives of Vauxmont Intermountain Communities (Vauxmont) notified six of the PRPs at the AERRCO site, including the company (AERRCO PRPs), that hazardous materials might have contaminated property owned by Vauxmont. The AERRCO site is contained within the RFIP site. Vauxmont also alleges that it lost $7 million on a contract with a home developer for the purchase of a portion of the land. Vauxmont representatives requested that the AERRCO PRPs study any contamination to the Vauxmont real estate. The AERRCO PRPs agreed to undertake such a study and sought the USEPA’s final approval. The sampling results were made available to all parties. No further claims have been made against the company by Vauxmont to date. Based on the information available to the company at the present time, the company does not believe that this matter will have a material adverse effect upon the liquidity, results of operations or financial condition of the company.
As previously reported, during July 1992, the company received information that it had been named a PRP with respect to the Solvents Recovery of New England Site (SRSNE) located in Southington, Connecticut. According to the information received, it is alleged that the company contributed approximately 0.08816 percent of the waste contributed to the site on a volumetric basis. The PRP group has been involved in negotiations with the USEPA regarding the remediation of the site. The company has paid approximately $17,500 toward site investigation and remediation efforts. The PRP group spent $15 million through the end of 2001. Approximately $1.5 million more was spent to complete a Remedial Investigation and Feasibility Study and pay for remediation work through 2003. As of December 2001, projected remediation cost estimates for a bioremediation and enhanced oxidation system ranged from $20 million to $30 million. The PRP group offered a $5.5 million settlement to resolve the USEPA claim of $16 million for past costs at the SRSNE site. PRP/USEPA negotiations to resolve the past cost claims from the USEPA have not been resolved and are not being actively pursued by the PRP group. A natural resources damage claim of approximately $3 million is anticipated. USEPA gave final approval for a $29 million remediation plan for the site on October 11, 2005. The cost of the site remedy is now expected to be between $35 million and $44 million. The company will be responsible for approximately 0.00109 percent of the future site costs. Based on the information available to the company at the present time, the company does not believe that this matter will have a material adverse effect upon the liquidity, results of operations or financial condition of the company.
On December 30, 2002, the company received a 104(e) letter from the USEPA pursuant to the Comprehensive Environmental Response Compensation and Liability Act (CERCLA) requesting answers to certain questions regarding the waste disposal practices of Heekin Can Company and the relationship between the company and Heekin Can Company. Region 5 of the USEPA is involved in the cleanup of the Jackson Brothers Paint Company site, which consists of four, and possibly five, sites in and around Laurel, Indiana. The Jackson Brothers Paint Company apparently disposed of drums of waste in those sites during the 1960s and 1970s. The USEPA has alleged that some of the waste that has been uncovered was sent to the sites from the Cincinnati plant operated by Heekin Can Company. The Indiana Department of Environmental Management referred this matter to the USEPA for removal of the drums and cleanup. At the present time there are an undetermined number of drums at one or more of the sites that have been initially identified by the USEPA as originating from Heekin Can Company. The USEPA has sent 104(e) letters to seven PRPs including Heekin Can Company. On January 30, 2003, the company responded to the request for information pursuant to Section 104(e) of CERCLA. The USEPA has initially estimated cleanup costs to be between $4 million and $5 million. Based on the information available to the company at the present time, the company does not believe that this matter will have a material adverse effect upon the liquidity, results of operations or financial condition of the company.
As previously reported, on October 6, 2005, Ball Metal Beverage Container Corp. (BMBCC), a wholly owned subsidiary of the company, was served with an amended complaint filed by Crown Packaging Technology, Inc. et. al. (Crown), in the U.S. District Court for the Southern District of Ohio, Western Division at Dayton, Ohio. The complaint alleges that the manufacture, sale and use of certain ends by BMBCC and its customers infringes certain claims of Crown’s U.S. patents. The complaint seeks unspecified monetary damages, fees, and declaratory and injunctive relief. BMBCC has formally denied the allegations of the complaint. A trial is currently set for May 7, 2007. Based on the information available to the company at the present time, the company does not believe that this matter will have a material adverse effect upon the liquidity, results of operations or financial condition of the company.
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As previously reported, on November 21, 2005, Ball Plastic Container Corp. (BPCC), a wholly owned subsidiary of the company, was served with a complaint filed by Constar International Inc. (Constar) in the U.S. District Court for the Western District of Wisconsin. The complaint alleged that the manufacture and sale of plastic bottles having oxygen barrier properties infringed certain claims of a Constar U.S. patent. Constar also sued Honeywell International Inc., the supplier of the oxygen barrier material to BPCC. The complaint sought monetary damages, fees and declaratory and injunctive relief. BPCC formally denied the allegations of the complaint. On July 26, 2006, this case was settled by the parties. This matter is now resolved without any material adverse effect upon the liquidity, results of operations or the financial condition of the company.
Ball Packaging Europe GmbH (BPE), together with certain other plaintiffs, contested the enactment of the mandatory deposit for non-returnable containers based on the German Packaging Regulation (Verpackungsverordnung) in Federal and State Administrative Court. All other proceedings have been terminated except for the determination of minimal court fees that are still outstanding in some cases, together with minimal ancillary legal fees.
In January 2003 the German government passed legislation that imposed a mandatory deposit of 25 eurocents on all one-way packages containing beverages except milk, wine, fruit juices and certain alcoholic beverages. The relevant industries, including BPE and its competitors, have successfully set up a Germany-wide return system for one-way beverage containers which has been operational since May 1, 2006, the date required under the deposit legislation. Based upon the information available to the company at the present time, the company does not believe that this matter will have a material adverse effect upon the liquidity, results of operations or financial condition of the company.
There were no matters submitted to the security holders during the fourth quarter of 2006.
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Ball Corporation common stock (BLL) is traded on the New York Stock Exchange and the Chicago Stock Exchange. There were 5,499 common shareholders of record on February 4, 2007.
Common Stock Repurchases
The following table summarizes the company’s repurchases of its common stock during the quarter ended December 31, 2006.
(a) Includes open market purchases and/or shares retained by the company to settle employee withholding tax liabilities.
(b) The company has an ongoing repurchase program for which shares are authorized from time to time by Ball’s board of directors.
(c) Does not include 1,200,000 shares under a forward share repurchase agreement entered into in December 2006 and settled on January 5, 2007, for approximately $52 million.
Quarterly Stock Prices and Dividends
Quarterly prices for the company's common stock, as reported on the New York Stock Exchange composite tape, and quarterly dividends in 2006 and 2005 (on a calendar quarter basis) were:
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Shareholder Return Performance
The line graph below compares the annual percentage change in Ball Corporation’s cumulative total shareholder return on its common stock with the cumulative total return of the S&P Composite 500 Stock Index and the Dow Jones Containers & Packaging Index for the five-year period ended December 31, 2006. It assumes $100 was invested on December 31, 2001, and that all dividends were reinvested. The Dow Jones Containers & Packaging Index total return has been weighted by market capitalization.
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Five-Year Review of Selected Financial Data
Ball Corporation and Subsidiaries
(1) Includes business consolidation activities and other items affecting comparability between years of pretax expense of $35.5 million and $21.2 million in 2006 and 2005, respectively, and pretax income of $15.2 million, $3.7 million and $2.3 million in 2004, 2003 and 2002, respectively. 2006 includes a $75.5 million pretax gain related to insurance proceeds in connection with a fire at one of Ball’s German plants. Also includes $19.3 million, $15.2 million and $5.2 million of debt refinancing costs in 2005, 2003 and 2002, respectively, reported as interest expense. Additional details about the 2006, 2005 and 2004 items are available in Notes 4, 5 and 12 to the consolidated financial statements within Item 8 of this report.
(2) Amounts have been retrospectively adjusted for the company’s change in 2006 from the last-in, first-out method of inventory accounting to the first-in, first-out method.
(3) Amounts have been retrospectively adjusted for a two-for-one stock split effected on August 23, 2004.
(4) Amount in 2006 does not include the offset of $61.3 million of insurance proceeds received in 2006 to replace fire-damaged assets in our Hassloch, Germany, plant.
(5) Market capitalization is defined as the number of common shares outstanding at year end, multiplied by the year-end closing price of Ball common stock. Net debt is total debt less cash and cash equivalents.
(6) Change in stock price plus dividend yield assuming reinvestment of all dividends paid.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Management’s discussion and analysis should be read in conjunction with the consolidated financial statements and 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.
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. We also supply aerospace and other technologies and services to governmental and commercial customers.
We sell our packaging products primarily to major beverage and food companies and producers of household products 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 diversified our customer base, we do 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 long-term relationships and contracts mitigate these risks.
In the rigid packaging industry, sales and earnings can be improved by reducing costs, developing new products, volume expansion and increasing pricing. In 2008 we expect to complete a project to upgrade and streamline our North American beverage can end manufacturing capabilities, a project that is expected to result in productivity gains and cost reductions beginning in 2007. 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 continuing to reconfigure some of our European can manufacturing lines and by having constructed a new beverage can manufacturing plant in Belgrade, Serbia, in 2005. To better position the company in the European market, the capacity from the fire-damaged Hassloch, Germany, plant will be replaced with a mix of steel beverage can manufacturing capacity in the Hassloch plant and aluminum beverage can manufacturing capacity in the company’s Hermsdorf, Germany, plant.
As part of our packaging strategy, we are focused on developing and marketing new and existing products that meet the needs of our customers. 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.
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 7A 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 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, and approximately one-third 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.
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Throughout the period of contract performance, we regularly reevaluate and, if necessary, revise our estimates of 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 valued added (operating earnings, as defined by the company, less a charge for net operating assets employed). Our goal is to increase economic valued 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 spoilage rates, quality control figures, 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 and retaining quality employees is 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 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 shares.
On March 27, 2006, Ball acquired all of the issued and outstanding shares of U.S. Can Corporation (U.S. Can) for consideration of 444,756 common shares of Ball Corporation (valued at $44.28 per share for a total of $19.7 million). In connection with the acquisition, Ball refinanced $598.2 million of U.S. Can debt, including $26.8 million of bond redemption premiums and fees, and over the next several years expects to realize approximately $42 million for acquired net operating tax loss carryforwards. As a result of this acquisition, Ball became the largest manufacturer of aerosol cans in North America and now manufactures aerosol cans, paint cans, plastic containers and custom and specialty cans in 10 plants in the U.S. and aerosol cans in two plants in Argentina. In October 2006 the company announced it would close an acquired plant in Alliance, Ohio. The acquired operations have annual sales of approximately $600 million. The acquired business forms part of Ball’s metal food and household products packaging, Americas, segment and its results have been included since the date of acquisition. Effective January 1, 2007, responsibility for the U.S. Can plastics business was transferred to our plastic packaging, Americas, segment.
On March 28, 2006, Ball acquired North American plastic bottle container assets from Alcan Packaging (Alcan) for $184.7 million cash. This acquisition strengthens the company’s plastic container business and complements its food container business. The acquired assets included two plastic container manufacturing plants in the U.S. and one in Canada, as well as certain manufacturing equipment and other assets from other Alcan facilities. The acquired business primarily manufactures and sells barrier polypropylene plastic bottles used in food packaging and, to a lesser extent, barrier PET plastic bottles used for beverages and food. The acquired operations have annual sales of approximately $150 million. The operations form part of Ball’s plastic packaging, Americas, segment and their results have been included since the date of acquisition.
The company refinanced U.S. Can’s debt at the time of the acquisition with significantly lower interest rates through the issuance by Ball Corporation of $450 million of new senior notes and a $500 million increase in bank debt under the senior credit facilities put in place in the fourth quarter of 2005. The proceeds of these financings were also used to acquire the Alcan operations and to reduce seasonal working capital debt.
On April 1, 2006, a fire in the metal beverage can plant in Hassloch, Germany, damaged the majority of the building and machinery and equipment. In November 2006 the company reached final agreement with the insurance carrier on property insurance and business interruption recoveries. Additional details are available in the “Consolidated Sales and Earnings” section for the “Metal Beverage Packaging, Europe/Asia” segment.
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In June 2006 the company’s U.S. defined benefit plans for salaried employees were amended to provide more flexibility for future pension benefits by allowing portability and changing the benefit to a career average pay scheme that grows by a prescribed amount annually. The annual accounting expense under the amended plans will be lower and more predictable. The amendments, which were effective January 1, 2007, reduced 2006 pension expense by approximately $7 million. We intend to reduce our current return on asset assumption for the U.S. pension plans to 8.25 percent for 2007, based upon current market conditions and anticipated long-term rate of return on plan assets, while increasing the discount rate assumption to 6 percent. Based on these assumptions and the 2006 salaried plan design changes, U.S. pension expense for 2007 is anticipated to increase $4 million compared to 2006, most of which will be included in cost of sales. Pension expense in Europe and Canada combined is expected to be slightly higher than the 2006 expense. A reduction of the plan asset return assumption by one quarter of a percentage point would result in additional expense of approximately $2.2 million while a quarter of a percentage point reduction in the discount rate would result in approximately $1.9 million of additional expense. Additional information regarding the company’s pension plans is provided in Note 14 accompanying the consolidated financial statements within Item 8 of this report.
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, (2) metal beverage packaging, Europe/Asia, (3) metal food and household products packaging, Americas, (4) plastic packaging, Americas, and (5) aerospace and technologies. 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. We expect a strong first quarter in 2007 as elevated raw material inventories are reduced to more normal levels.
During the fourth quarter of 2006, Ball’s management changed its method of inventory accounting for certain invnetories from the last-in, first-out (LIFO) method to the first-in, first-out (FIFO) method in the metal beverage, Americas, and the metal food and household products packaging, Americas, segments. All periods presented have been retrospectively adjusted on a FIFO basis. In the third quarter of 2006, the company changed its expense allocation method by allocating to each of the packaging segments stock-based compensation expense previously included in corporate undistributed expenses. The change did not have a significant impact on any segment for the current or prior years. Prior periods have been conformed to the current presentation of the segments and the change in expense allocation.
Metal Beverage Packaging, Americas
The metal beverage packaging, Americas, segment consists of operations located in the U.S., Canada and Puerto Rico, which manufacture products used primarily in beverage packaging. This segment accounted for 39 percent of consolidated net sales in 2006 (42 percent in 2005). Sales were 9 percent higher in 2006 than in 2005 due to more than 4 percent higher beverage can shipments coupled with higher aluminum prices passed through to our customers. The increased sales over 2005 were also driven by favorable weather in many parts of the U.S. and Canada, as well as the promotion of 12-ounce can packages by beer and soft drink companies. Sales in 2005 were slightly higher than in 2004 as lower 2005 sales volumes were offset by the pass through of higher aluminum prices. Metal beverage container volumes in 2005 were 2.5 percent below the previous year’s levels as a result of poor weather in the first quarter, temporary volume reductions and general softness in the beer and carbonated soft drink markets. Based on publicly available information, we estimate that our shipments of metal beverage containers were approximately 32 percent of total U.S. and Canadian shipments in 2006.
We continue to focus efforts on the growing custom beverage can business, which includes cans of different shapes, diameters and fill volumes, and cans with added functional attributes for new products and product line extensions. During the first quarter of 2006, we completed the conversion of a line in our Monticello, Indiana, plant from 12-ounce can manufacturing to a line capable of producing other sizes.
Earnings in the segment were $269.4 million in 2006 compared to $234.8 million in 2005 and $275.7 million in 2004. The third quarter of 2005 included a pretax charge of $19.3 million ($11.7 million after tax) related to a project to significantly upgrade and streamline our North American beverage can end manufacturing capabilities. The charge included the write off of obsolete equipment spare parts and tooling, as well as employee termination costs. Over time, this capital project is expected to result in productivity improvements and reduced manufacturing
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costs. We have installed and are operating three of eight production modules in this multi-year project and the fourth and fifth modules are in the installation phase. The project is expected to be completed in 2008. In connection with this project, the can end manufacturing operations at the Reidsville, North Carolina, plant were shut down during the fourth quarter of 2006.
Despite higher sales in 2006, segment earnings growth was constrained by product mix and continued year-over-year cost growth, particularly higher energy, other direct material and freight costs, which were $21 million more than in 2005. While contract price escalations have commenced for many of our customers, cost growth has continued to outpace price increases. Energy, freight and other direct material costs were $32 million higher in 2005 than in 2004, partially offset by efficiency gains, cost controls and lower selling, general and administrative costs in 2005. While pricing pressures continue on our raw materials, other direct materials, and freight and utility costs, we continue to work with both customers and suppliers to maintain our volumes, as well as preserve our margins.
Metal Beverage Packaging, Europe/Asia
The metal beverage packaging, Europe/Asia, segment includes the production and sale of metal beverage container products manufactured and sold in Europe and Asia as well as plastic containers manufactured and sold in Asia. This segment accounted for 23 percent of consolidated net sales in 2006 (24 percent in 2005). Ball Packaging Europe, which represents an estimated 29 percent of the total European metal beverage container manufacturing capacity, has manufacturing plants located in Germany, the United Kingdom, France, the Netherlands, Poland and Serbia.
Due to strong demand, segment can shipments were more than 9 percent higher in 2006 than in 2005. Higher segment sales volumes were aided by favorable European weather and Germany hosting the World Cup soccer championship during June and July 2006, as well as by continued growth in the China market. Segment sales, which grew 12 percent in 2006, also benefited from the strength of the euro. Segment sales were approximately 9 percent higher in 2005 than in 2004 primarily as a result of an increase in sales volumes.
The slow return of the can to the German market, as a result of the mandatory deposit legislation previously reported on, is being more than offset by stronger demand elsewhere in Europe, including southern and eastern Europe. We expect PRC demand for aluminum beverage cans to grow in the coming years, as both multinational and Chinese beverage fillers expand their markets.
The construction of a new beverage can plant in Belgrade, Serbia, was completed near the end of the second quarter of 2005 to serve the growing demand for beverage cans in southern and eastern Europe. The plant became fully operational during the third quarter of 2005. The Serbian plant was constructed to accommodate a second can production line and a can end manufacturing module for future growth.
Earnings in the segment were $268.7 million in 2006, $180.5 million in 2005 and $195.1 million in 2004. Segment earnings in 2006 included a $75.5 million property insurance gain related to a fire at the company’s Hassloch, Germany, metal beverage can plant (further details are provided in the “Recent Developments” section). The third quarter of 2006 also included a gain of $5.5 million related to the change in an estimated liability. The fourth quarter of 2005 included a $9.3 million gain primarily resulting from the final settlement of all tax obligations related to liquidated China operations for amounts less than originally estimated. First quarter 2005 segment earnings included a $3.4 million expense for the write off of the remaining carrying value of an equity investment in the PRC. Earnings in 2004 included income of $13.7 million related to the realization of proceeds on assets in the PRC being in excess of amounts previously estimated, and costs of liquidation being less than anticipated in a prior year business consolidation charge.
Segment earnings in 2006 were higher than in 2005 due to the property insurance gain, higher volumes, price recovery initiatives and effective manufacturing and selling, general and administrative cost controls; partially offset by higher raw material, freight and energy costs, and price/cost compression in the PRC. Higher material, energy and transportation costs, as well as second and third quarter start up costs related to a line conversion in the Netherlands and the new Serbia plant, had a negative effect on 2005 segment earnings compared to 2004. Partially offsetting these higher costs were lower selling, general and administrative costs.
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On April 1, 2006, a fire in the metal beverage can plant in Hassloch, Germany, damaged the majority of the building, machinery and equipment. The property insurance proceeds recorded for the year ended December 31, 2006, which are based on replacement cost, were €86.3 million ($109.3 million), of which €26 million ($32.4 million) was received in April 2006, €22.7 million ($28.9 million) was received in October 2006 and the remainder of €37.6 million ($49.6 million), which was recorded in other long-term assets, was received in January 2007. A €26.7 million ($33.8 million) fixed asset write down was recorded to reflect the estimated impairment of the assets damaged as a result of the fire. As a result, a gain of €59.6 million ($75.5 million pretax) was recorded in the 2006 consolidated statement of earnings to reflect the difference between the net book value of the impaired assets and the property insurance proceeds. An additional €15 million ($19 million), €13 million ($16.5 million) and €12 million ($15.5 million) were recorded in cost of sales in the second, third and fourth quarters, respectively, for insurance recoveries related to business interruption costs, as well as €11.3 million ($14.3 million) to offset clean-up costs. An additional €27 million of business interruption recoveries has been agreed upon with the insurance carrier and will be recognized in 2007.
In June 2006 the company announced its intention to rebuild the Hassloch plant with two steel lines and to add an aluminum line in its Hermsdorf, Germany, plant. All three lines are expected to be operational during the second quarter of 2007.
In the fourth quarter of 2006, we acquired the minority interest in our two PRC high-density plastic joint ventures for $4.6 million in cash. During the fourth quarter of 2004, Sanshui Jianlibao FTB Packaging Limited (Sanshui JFP), a 35 percent owned PRC joint venture, experienced a greater than customary seasonal production slowdown caused by cash flow difficulties. In response, we recorded an allowance for doubtful accounts in respect of Sanshui JFP’s receivable from the joint venture partner for $15.2 million, which was included in the 2004 consolidated statement of earnings as equity in results of affiliates. Information learned late in the first quarter of 2005 led the company to record expense of $3.4 million to write off the remaining carrying value of this investment.
Earnings of $9.3 million and $13.7 million in 2005 and 2004, respectively, were recognized as PRC restructuring activities that commenced in 2001 were completed, resulting in realization on assets in excess of amounts previously estimated, as well as costs incurred being less than estimated, including settlement of tax matters. All costs and transactions related to the PRC restructuring have been concluded.
Additional details regarding business consolidation activities are available in Note 4 accompanying the consolidated financial statements included within Item 8 of this Annual Report.
Metal Food and Household Products Packaging, Americas
The metal food and household products packaging, Americas, segment consists of operations located in the U.S., Canada and Argentina. With the acquisition of U.S. Can (discussed in the “Recent Developments” section), the segment added to its metal food can manufacturing the production of aerosol cans, paint cans, certain plastic containers and custom and specialty cans. Segment sales in 2006 comprised 18 percent of consolidated net sales (14 percent in 2005) and were 44 percent higher than 2005 sales. The primary reason for the increase was the acquisition of U.S. Can. The favorable impact on 2006 sales of the pass through of higher raw material costs was offset by lower third quarter food can volumes. Sales in 2005 were 6 percent higher than in 2004, reflecting higher prices from the pass through of higher raw material costs. Sales volumes were flat compared to 2004 levels including, in the first quarter of 2005, the inclusion of a full quarter’s results from our Oakdale, California, facility, which was acquired in March 2004. During 2006, 2005 and 2004, we were able to pass through the majority of the steel price increases and surcharges levied by steel producers. Based on publicly available trade information, we estimate our 2006 shipments of more than 6 billion steel food containers and 1.7 billion aerosol containers to be approximately 20 percent and 53 percent of total U.S. and Canadian metal food container and steel aerosol container shipments, respectively.
Segment earnings were $6 million in 2006 compared to $19.1 million in 2005 and $46.4 million in 2004. The fourth quarter of 2006 included a pretax charge of $33.8 million, primarily for the closure of a metal food can manufacturing plant in Burlington, Ontario, as part of the realignment of the segment following the U.S. Can acquisition (discussed in more detail below). The first six months of 2006 included a net pretax charge of $1.7 million primarily related to the shut down of a metal food can manufacturing line in the Whitby, Ontario, plant.
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The fourth quarter of 2005 included a pretax charge of $4.6 million ($3.1 million after tax) for pension, severance and other employee benefit costs related to a reduction in force in the Burlington plant. The second quarter of 2005 included a pretax charge of $8.8 million ($5.9 million after tax) for the closure of a three-piece food can manufacturing plant in Quebec. The Quebec plant was closed and ceased operations in the third quarter of 2005 and an agreement was reached to sell the land and building, which resulted in the second quarter charge being offset by a $2.2 million gain ($1.5 million after tax) in the fourth quarter of 2006 to adjust the plant to net realizable value.
Higher sales volumes related to the U.S. Can acquisition helped improve segment earnings in the last nine months of 2006, despite the negative impact of lower food can volumes attributable to the loss of a customer in late 2005 and a poor salmon harvest in 2006. Additionally, segment earnings in 2006 were reduced by purchase accounting adjustments of $6.1 million, which increased cost of sales due to inventory valuations associated with the acquired U.S. Can finished goods inventory. Contributing to lower segment earnings in 2005 compared to 2004 were higher freight costs from fuel surcharges and higher other direct material and utility costs. Energy, freight and other direct material costs were $16 million higher in 2005 than in 2004, partially offset by efficiency gains, cost controls and lower selling, general and administrative costs in 2005. While pricing pressures continue on all of our raw materials, other direct materials and freight and utility costs, we continue to work with both customers and suppliers to maintain our volumes, as well as to preserve our margins.
In October 2006 the company announced plans to close two manufacturing facilities in North America by the end of 2006 as part of the realignment of the metal food and household products packaging, Americas, segment following the acquisition of U.S. Can earlier in the year. The company closed a leased facility in Alliance, Ohio, which was one of 10 manufacturing locations acquired from U.S. Can, and a plant in Burlington, Ontario, which was part of the metal food can operations prior to the U.S. Can acquisition. A pretax charge of $33.8 million ($27.5 million after tax) was recorded in the fourth quarter, primarily related to the Burlington closure for employee termination and pension costs, plant decommissioning costs and fixed asset impairment. The closure of the Ohio plant has been treated as an opening balance sheet item. The estimated costs of the closures will be cash flow neutral after tax benefits and anticipated proceeds from the sale of fixed assets. The company continues to evaluate the segment’s manufacturing structure and expects to identify other opportunities to improve efficiencies.
Additional details regarding business consolidation activities are available in Note 4 accompanying the consolidated financial statements included within Item 8 of this Annual Report.
Plastic Packaging, Americas
The plastic packaging, Americas, segment consists of operations located in the U.S. and Canada which manufacture polyethylene terephthalate (PET) and polypropylene plastic container products used mainly in beverage and food packaging. Segment sales in 2006 comprised 10 percent of consolidated sales (8 percent in 2005) and increased 32 percent compared to 2005 due largely to the plant and other asset acquisitions from Alcan and higher PET bottle volumes. We continue to focus PET development efforts in the custom hot-fill, beer, wine, flavored alcoholic beverage and specialty container markets, and we are adding specialty container production capacity to accommodate new demand. In the food and specialty area, development efforts are focused on custom markets as well.
The 22 percent sales increase in 2005 compared to 2004 was largely due to the pass through to our customers of higher resin prices, as well as 7.5 percent higher sales volumes in 2005 compared to 2004 as a result of higher demand for barrier and heat-set containers that provide longer shelf-life for products, combined with strong demand for plastic water bottles. Although only a small percentage of our total volume, sales of juice, sports drink and beer containers increased in 2006. These sales are expected to grow in the future as more focus is placed on such specialty markets and the development of our Heat-Tek(TM) business. We estimate our 2006 shipments of more than 5.7 billion PET plastic containers to be approximately 9 percent of total U.S. and Canadian PET container shipments. In addition, the plastic packaging, Americas, segment produced more than 640 million food and specialty containers during 2006.
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Segment earnings were $24.7 million in 2006 compared to $16.7 million in 2005 and $9.6 million in 2004. Segment earnings in 2006 were higher than in 2005 largely due to the incremental sales from the Alcan acquisition, but were partially offset by energy cost increases of approximately $6 million, the timing of resin cost increases and costs incurred for a litigation claim that was favorably resolved in July 2006. Earnings in the second quarter of 2006 also included purchase accounting adjustments of $1.2 million, which increased cost of sales due to the valuation of inventories associated with the acquired Alcan finished goods inventory. In 2007 the plastic packaging, Americas, segment will include the sales and earnings of a plastic pail business which was recorded in the 2006 operating results of the metal food and household products packaging, Americas, segment.
The improvement in earnings in 2005 over 2004 was the result of higher sales and production volumes and growth in specialty products. Partially offsetting these improvements in 2005 were higher utility costs. Segment earnings in 2004 were reduced by $1.3 million, primarily related to costs associated with the relocation of the plastics offices and research and development facility from Atlanta, Georgia, to Colorado. Earnings in 2004 were also negatively impacted by continued pricing pressures on plastic containers for carbonated soft drink and water customers.
Aerospace and Technologies
Aerospace and technologies segment sales represented 10 percent of 2006 consolidated net sales (12 percent in 2005) and were 3 percent lower than in 2005. Sales in 2005 were 6 percent higher than in 2004. The lower 2006 sales were largely due to contracts being completed during the period, as well as the impact of government funding reductions and program delays. Higher sales in 2005 compared to 2004 resulted from a combination of newly awarded contracts and additions to previously awarded contracts. The aerospace and technologies business won a number of large, strategic contracts and delivered a considerable amount of sophisticated space and defense instrumentation throughout the three-year period.
Segment earnings were $50 million in 2006, $54.7 million in 2005 and $48.7 million in 2004. The first quarter of 2005 included expense of $3.8 million for the write down to net realizable value of an equity investment in an aerospace company. This investment was sold in October 2005 for approximately its carrying value. Earnings in 2006 were negatively affected by the lower sales due to program delays and unfavorable contract mix. The improvement in 2005 earnings compared to 2004 was primarily the result of higher sales and improved program performance.
Some of the segment’s high-profile contracts include: WorldView 1 and WorldView 2, advanced commercial remote sensing satellites; the James Webb Space Telescope, a successor to the Hubble Space Telescope; the Space-Based Space Surveillance System, which will detect and track space objects such as satellites and orbital debris; NPOESS, the next-generation satellite weather monitoring system; and a number of antennas for the Joint Strike Fighter.
Sales to the U.S. government, either directly as a prime contractor or indirectly as a subcontractor, represented 90 percent of segment sales in 2006, 87 percent in 2005 and 82 percent in 2004. Contracted backlog for the aerospace and technologies segment at December 31, 2006 and 2005, was $886 million and $761 million, respectively. Year-to-year comparisons of backlog are not necessarily indicative of the trend of future operations.
Additional Segment Information
For additional information regarding the company’s segments, see the summary of business segment information in Note 2 accompanying the consolidated financial statements within Item 8 of this report. The charges recorded for business consolidation activities were based on estimates by Ball management, actuaries and other independent parties and were developed from information available at the time. If actual outcomes vary from the estimates, the differences will be reflected in current period earnings in the consolidated statement of earnings and identified as business consolidation gains and losses. Additional details about our business consolidation activities and associated costs are provided in Note 4 accompanying the consolidated financial statements within Item 8 of this report.
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Selling, General and Administrative Expenses
Selling, general and administrative (SG&A) expenses were $287.2 million, $233.8 million and $268.8 million for 2006, 2005 and 2004, respectively. The increase in SG&A expenses in 2006 compared to 2005 was primarily the result of $20 million of incremental SG&A (after realized synergies) from the acquired U.S. Can operations, a $5.8 million out-of-period adjustment (discussed below), higher expense of $6.3 million associated with the adoption of SFAS No. 123 (revised 2004), $2 million for higher rates associated with the company’s receivables sales agreement, $5 million of increased legal fees related to patent litigation, $6.7 million for an initial mark-to-market adjustment to one of the company’s deferred compensation stock plans due to a plan amendment and normal compensation and benefit increases. Expenses in 2005 were lower than 2004 in all areas of the company due largely to lower employee compensation and benefit costs, including the company’s deposit share program and economic-value-added based incentive compensation plans. These lower costs were partially offset by higher pension costs, higher accounts receivable securitization fees and the write down of the PRC and aerospace equity investments in the first quarter of 2005.
Subsequent to the issuance of its financial statements for the year ended December 31, 2005, the company determined that certain foreign currency exchange losses had been inadvertently deferred for the years 2005, 2004 and 2003. Since the amounts were not material, individually or in the aggregate, to any previously issued financial statements or to our full year results of operations for 2006, a cumulative $5.8 million out-of-period adjustment was included in SG&A expenses in the first quarter of 2006.
On October 26, 2005, Ball’s board of directors approved the accelerated vesting of the out-of-the-money, unvested nonqualified stock options granted in April 2005. The acceleration affected approximately 665,000 options granted to approximately 290 employees at an exercise price of $39.74. The accelerated vesting of these nonqualified options allowed the company to eliminate approximately $5 million of pretax expense (approximately $3 million after tax) combined for 2006 to 2009.
Interest and Taxes
Consolidated interest expense was $134.4 million in 2006; $116.4 million, including debt refinancing costs of $19.3 million, in 2005 and $103.7 million in 2004. The higher expense in 2006 was primarily due to the additional borrowings used to finance the acquisitions of U.S. Can and the Alcan assets. The lower expense in 2005 compared to 2004 was due to lower average borrowings and higher capitalized interest. The debt refinancing costs in 2005 of $19.3 million were costs associated with the refinancing of the company’s senior credit facilities and the redemption in the last half of 2005 of the company’s 7.75% senior notes, which were due in August 2006.
Ball’s consolidated effective income tax rate for 2006 was 29.4 percent compared to 29.2 percent in 2005 and 32.2 percent in 2004. While the effective tax rates for 2006 and 2005 are similar, the 2006 rate was impacted by a one-time tax benefit of $8.1 million associated with a foreign exchange loss as a result of the change in the functional currency of a European subsidiary in the local statutory accounts. The one-time benefit was somewhat offset by a higher foreign tax rate differential due to taxation of the German property insurance gain at the marginal rate of 39% and a valuation allowance on a Canadian net operating loss resulting from the 2006 business consolidation costs. The 2005 rate was impacted by the tax benefit recorded on the repatriation of foreign earnings (see further discussion below) plus the tax benefit on business consolidation costs applied at the higher marginal rate.
The decrease in the 2005 effective tax rate compared to 2004 is primarily due to the net tax benefit recorded on the repatriation of foreign earnings under the American Jobs Creation Act of 2004 (Jobs Act), the tax benefit on business consolidation costs applied at the marginal tax rate, increased research and development tax credits and the manufacturing deduction effective in 2005 under the Jobs Act. (Further details of the amounts repatriated under the Jobs Act are available in Note 13 accompanying the consolidated financial statements within Item 8 of this report.) These benefits were somewhat offset by the fact that no tax benefit was provided in respect of the equity investment write downs in the first quarter of 2005. The $3.8 million write down of the aerospace investment is not tax deductible while the realization of tax deductibility of the $3.4 million PRC write down, which will be a capital loss, is not reasonably assured as the company does not have, nor does it anticipate, any capital gains to offset the capital losses.
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In connection with the Internal Revenue Service’s (IRS) examination of Ball’s consolidated income tax returns for the tax years 2000 through 2004, the IRS has proposed to disallow Ball’s deductions of interest expense incurred on loans under a company-owned life insurance plan that has been in place for more than 20 years. Ball believes that its interest deductions will be sustained as filed and, therefore, no provision for loss has been recorded. The total potential liability for the audit years 1999 through 2004, unaudited year 2005 and an estimate of the impact on 2006 is approximately $31 million, excluding related interest. The IRS has withdrawn its proposed adjustments for any penalties. See Note 13 accompanying the consolidated financial statements within Item 8 of this Annual Report.
Results of Equity Affiliates
Equity in the earnings of affiliates in 2006 is primarily attributable to our 50 percent ownership in packaging investments in the U.S. and Brazil. Earnings in 2004 included the results of a minority-owned aerospace business, which was sold in October 2005, and a $15.2 million loss representing Ball’s share of a provision for doubtful accounts relating to its 35 percent interest in Sanshui JFP (discussed above in “Metal Beverage Packaging, Europe/Asia”). After consideration of the PRC loss, earnings were $14.7 million in 2006 compared to $15.5 million in 2005 and $15.8 million in 2004.
CRITICAL AND SIGNIFICANT ACCOUNTING POLICIES AND NEW ACCOUNTING PRONOUNCEMENTS
For information regarding the company’s critical and significant accounting policies, as well as recent accounting pronouncements, see Note 1 to the consolidated financial statements within Item 8 of this report.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Cash Flows and Capital Expenditures
Cash flows from operating activities were $401.4 million in 2006 compared to $558.8 million in 2005 and $535.9 million in 2004.
Management internally uses a free cash flow measure: (1) to evaluate the company’s operating results, (2) for planning purposes, (3) to evaluate strategic investments and (4) to evaluate the company’s ability to incur and service debt. Free cash flow is not a defined term under U.S. generally accepted accounting principles, and it should not be inferred that the entire free cash flow amount is available for discretionary expenditures. The company defines free cash flow as cash flow from operating activities less additions to property, plant and equipment (capital spending). Free cash flow is typically derived directly from the company’s cash flow statements; however, it may be adjusted for items that affect comparability between periods. An example of such an item included in 2006 is the property insurance proceeds for the replacement of the fire-damaged assets in our Hassloch, Germany, plant, which is included in capital spending amounts.
Based on this, our consolidated free cash flow is summarized as follows:
Cash flows from operating activities in 2006 were negatively affected by higher cash pension funding and higher working capital levels compared to the prior year. The higher working capital was a combination of higher than planned raw material inventory levels, higher income tax payments and higher accounts receivable balances, the latter resulting primarily from the repayment of a portion of the accounts receivable securitization program and late payments from customers in Europe. Management expects the increase in working capital to be temporary and that working capital levels will return to normal levels by the end of the first half of 2007.
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Cash flow in 2005 compared to 2004 was negatively impacted by higher cash taxes. This resulted in a decrease in deferred income taxes payable of $51.6 million in 2005 compared to an estimated increase in deferred taxes of $47 million in 2004. The primary causes of the increase in current income taxes and decrease in deferred income taxes were the reduction in 2005 of tax-deductible pension costs versus 2004, the impact in 2005 of the repatriation of foreign earnings and a reduction of tax versus book depreciation expense as tax depreciation was accelerated in prior years, primarily due to bonus tax depreciation permitted in the tax laws after September 11, 2001. Cash flows from operating activities were positively affected in 2005 by lower accounts receivable, higher accounts payable and lower pension contributions.
Based on information currently available, we estimate cash flows from operating activities for 2007 to be approximately $600 million, capital spending (net of property insurance recoveries) to be approximately $250 million and free cash flow to be in the $350 million range. Capital spending of $218.3 million (net of $61.3 million in insurance recoveries) in 2006 was below depreciation and amortization expense of $252.6 million. We continue to invest capital in our best performing operations, including projects to increase custom can capabilities, improve beverage can end making productivity and convert lines from steel to aluminum in Europe, as well as expenditures in the aerospace and technologies segment.
Debt Facilities and Refinancing
Interest-bearing debt at December 31, 2006, increased $862 million to $2,451.7 million from $1,589.7 million at December 31, 2005. This increase includes the issuance by Ball Corporation in March 2006 of $450 million of 6.625% senior notes due in 2018 and a $500 million increase in bank debt under Ball Corporation’s senior credit facilities put in place in the fourth quarter of 2005. The proceeds from these financings were used to refinance existing U.S. Can debt at lower interest rates, acquire certain net assets of Alcan and reduce seasonal working capital debt. Other than acquisition related debt, the 2006 debt increase from 2005 was primarily attributed to changes in foreign exchange rates.
At December 31, 2006, $675 million was available under the company’s multi-currency revolving credit facilities. The company also had $329 million of short-term uncommitted credit facilities available at the end of the year, of which $140.1 million was outstanding.
On October 13, 2005, Ball refinanced its senior secured credit facilities and during the third and fourth quarters of 2005, Ball redeemed its 7.75% senior notes due August 2006 primarily through the drawdown of funds under the new credit facilities. The refinancing and redemption resulted in a pretax debt refinancing charge of $19.3 million ($12.3 million after tax) to reflect the call premium associated with the senior notes and the write off of unamortized debt issuance costs.
During the first quarter of 2004, Ball repaid €31 million ($38 million) of its previous euro denominated Term Loan B and reduced the interest rate by 50 basis points. During the fourth quarter of 2003, Ball repaid $160 million of its previous U.S. dollar denominated Term Loan B and €25 million of its previous euro denominated Term Loan B. At the time of the early repayment, the interest rate on the U.S. portion of the Term Loan B was reduced by 50 basis points. Interest expense during the first quarter of 2004 included $0.5 million for the write off of the unamortized financing costs associated with the repaid loans.
The company has a receivables sales agreement that provides for the ongoing, revolving sale of a designated pool of trade accounts receivable of Ball’s North American packaging operations, up to $225 million. The agreement qualifies as off-balance sheet financing under the provisions of Statement of Financial Accounting Standards (SFAS) No. 140, as amended by SFAS No. 156. Net funds received from the sale of the accounts receivable totaled $201.3 million and $210 million at December 31, 2006 and 2005, respectively, and are reflected as a reduction of accounts receivable in the consolidated balance sheets.
The company was not in default of any loan agreement at December 31, 2006, and has met all payment obligations. The U.S. note agreements, bank credit agreement and industrial development revenue bond agreements contain certain restrictions relating to dividends, investments, financial ratios, guarantees and the incurrence of additional indebtedness.
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Additional details about the company’s receivables sales agreement and debt are available in Notes 6 and 12, respectively, accompanying the consolidated financial statements within Item 8 of this report.
Other Liquidity Items
Cash payments required for long-term debt maturities, rental payments under noncancellable operating leases and purchase obligations in effect at December 31, 2006, are summarized in the following table:
(a) Amounts reported in local currencies have been translated at the year-end exchange rates.
(b) For variable rate facilities, amounts are based on interest rates in effect at year end.
(c) The company’s purchase obligations include contracted amounts for aluminum, steel, plastic resin and other direct materials. Also included are commitments for purchases of natural gas and electricity, aerospace and technologies contracts and other less significant items. In cases where variable prices and/or usage are involved, management’s best estimates have been used. Depending on the circumstances, early termination of the contracts may not result in penalties and, therefore, actual payments could vary significantly.
Contributions to the company’s defined benefit pension plans, not including the unfunded German plans, are expected to be $69.1 million in 2007. This estimate may change based on plan asset performance. Benefit payments related to these plans are expected to be $62.6 million, $65.1 million, $68.9 million, $73.9 million and $75.1 million for the years ending December 31, 2007 through 2011, respectively, and $436.7 million combined for 2012 through 2016. Payments to participants in the unfunded German plans are expected to be $24.6 million, $25.1 million, $25.5 million, $25.9 million and $26.1 million in the years 2007 through 2011, respectively, and a total of $136.6 million thereafter.
We reduced our share repurchase program in 2006 to $45.7 million, net of issuances, compared to $358.1 million net repurchases in 2005 and $50 million in 2004. The net repurchases in 2006 did not include a forward contract entered into in December 2006 for the repurchase of 1,200,000 shares. The contract was settled on January 5, 2007, for $51.9 million in cash. In 2007 we expect to repurchase approximately $175 million, net of issuances, and to reduce debt levels by more than $125 million. Annual cash dividends paid on common stock were 40 cents per share in 2006 and 2005 and 35 cents per share in 2004. Total dividends paid were $41 million in 2006, $42.5 million in 2005 and $38.9 million in 2004.
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The company is subject to various risks and uncertainties in the ordinary course of business due, in part, to the competitive nature of the industries in which we participate, our operations in developing markets outside the U.S., changing commodity prices for the materials used in the manufacture of our products and changing capital markets. Where practicable, we attempt to reduce these risks and uncertainties through the establishment of risk management policies and procedures, including, at times, the use of derivative financial instruments as explained in Item 7A of this report.
From time to time, the company is subject to routine litigation incident to its business. Additionally, the U.S. Environmental Protection Agency has designated Ball as a potentially responsible party, along with numerous other companies, for the cleanup of several hazardous waste sites. Our information at this time does not indicate that these matters will have a material adverse effect upon the liquidity, results of operations or financial condition of the company.
Due to political and legal uncertainties in Germany, no nationwide system for returning beverage containers was in place at the time a mandatory deposit was imposed in January 2003, and nearly all retailers stopped carrying beverages in non-refillable containers. We responded to the resulting lower demand for beverage cans with several measures including reducing capacity and converting production lines from steel to aluminum to facilitate exports from Germany to other European countries. Since May 1, 2006, all retailers have been required to redeem all returned one-way containers as long as they sell such containers. Many retailers in Germany have begun the process of implementing a returnable system for one-way containers. The retailers and the filling and packaging industries have formed a committee to design a nationwide recollection system and several retailers have ordered and installed reverse vending machines in order to streamline the recollection system. One-way packaging sales by German retailers have increased significantly since May 1, 2006 (albeit off a low base). We believe it will take some time to recover from the significant decrease experienced beginning in 2003. Usage will increase as one-way collection systems are more fully developed and consumers become educated regarding the systems and the reintroduction of one-way packaging.
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingencies at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Future events could affect these estimates. See Note 1 to the consolidated financial statements within Item 8 of this report for a summary of the company’s critical and significant accounting policies.
The U.S. and European economies have experienced minor general inflation during the past several years. Management believes that evaluation of Ball’s performance during the periods covered by these consolidated financial statements should be based upon historical financial statements.
As described in Note 13 accompanying the consolidated financial statements within Item 8 of this Annual Report, the IRS has proposed to disallow Ball’s deductions of interest expense for the tax years 2000 through 2004 incurred on loans under a company-owned life insurance plan that was established in 1986. Ball has disputed the IRS’s claims and the company believes the interest deductions will be sustained as filed.
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The company has made or implied certain forward-looking statements in this report which are made as of the end of the time frame covered by this report. These forward-looking statements represent the company’s goals, and results could vary materially from those expressed or implied. From time to time we also provide oral or written forward-looking statements in other materials we release to the public. As time passes, the relevance and accuracy of forward-looking statements may change. Some factors that could cause the company’s actual results or outcomes to differ materially from those discussed in the forward-looking statements include, but are not limited to: fluctuation in customer and consumer growth, demand and preferences; loss of one or more major customers or changes to contracts with one or more customers; insufficient production capacity; overcapacity in foreign and domestic metal and plastic container industry production facilities and its impact on pricing; failure to achieve anticipated productivity improvements or production cost reductions, including those associated with capital expenditures such as our beverage can end project; changes in climate and weather; fruit, vegetable and fishing yields; power and natural resource costs; difficulty in obtaining supplies and energy, such as gas and electric power; availability and cost of raw materials, as well as the recent significant increases in resin, steel, aluminum and energy costs, and the ability or inability to include or pass on to customers changes in raw material costs; changes in the pricing of the company’s products and services; competition in pricing and the possible decrease in, or loss of, sales resulting therefrom; insufficient or reduced cash flow; transportation costs; the number and timing of the purchases of the company’s common shares; regulatory action or federal and state legislation including mandated corporate governance and financial reporting laws; the German mandatory deposit or other restrictive packaging legislation such as recycling laws; interest rates affecting our debt; labor strikes; increases and trends in various employee benefits and labor costs, including pension, medical and health care costs; rates of return projected and earned on assets and discount rates used to measure future obligations and expenses of the company’s defined benefit retirement plans; boycotts; antitrust, intellectual property, consumer and other litigation; maintenance and capital expenditures; goodwill impairment; changes in generally accepted accounting principles or their interpretation; accounting changes; local economic conditions; the authorization, funding, availability and returns of contracts for the aerospace and technologies segment and the nature and continuation of those contracts and related services provided thereunder; delays, extensions and technical uncertainties, as well as schedules of performance associated with such segment contracts; international business and market risks such as the devaluation or revaluation of certain currencies and the activities of foreign subsidiaries; international business risks (including foreign exchange rates and activities of foreign subsidiaries) in Europe and particularly in developing countries such as the PRC and Brazil; changes in the foreign exchange rates of the U.S. dollar against the European euro, British pound, Polish zloty, Serbian dinar, Hong Kong dollar, Canadian dollar, Chinese renminbi, Brazilian real and Argentine peso, and in the foreign exchange rate of the European euro against the British pound, Polish zloty and Serbian dinar; terrorist activity or war that disrupts the company’s production or supply; regulatory action or laws including tax, environmental and workplace safety; technological developments and innovations; successful or unsuccessful acquisitions, joint ventures or divestitures and the integration activities associated therewith; changes to unaudited results due to statutory audits of our financial statements or management’s evaluation of the company’s internal controls over financial reporting; and loss contingencies related to income and other tax matters, including those arising from audits performed by U.S. and foreign tax authorities. If the company is unable to achieve its goals, then the company’s actual performance could vary materially from those goals expressed or implied in the forward-looking statements. The company currently does not intend to publicly update forward-looking statements except as it deems necessary in quarterly or annual earnings reports. You are advised, however, to consult any further disclosures we make on related subjects in our 10-K, 10-Q and 8-K reports to the Securities and Exchange Commission.
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Financial Instruments and Risk Management
In the ordinary course of business, we employ established risk management policies and procedures to reduce our exposure to fluctuations in commodity prices, interest rates, foreign currencies and prices of the company’s common stock in regard to common share repurchases. Although the instruments utilized involve varying degrees of credit, market and interest risk, the counterparties to the agreements are expected to perform fully under the terms of the agreements.
We have estimated our market risk exposure using sensitivity analysis. Market risk exposure has been defined as the changes in fair value of derivative instruments, financial instruments and commodity positions. To test the sensitivity of our market risk exposure, we have estimated the changes in fair value of market risk sensitive instruments assuming a hypothetical 10 percent adverse change in market prices or rates. The results of the sensitivity analysis are summarized below.
Commodity Price Risk
We manage our commodity price risk in connection with market price fluctuations of aluminum primarily by entering into container sales contracts which generally include aluminum-based pricing terms that consider price fluctuations under our commercial supply contracts for aluminum purchases. Such terms generally include a fixed price, floating price or an upper limit to the aluminum component pricing. This matched pricing affects substantially all of our metal beverage packaging, Americas, net sales. We also, at times, use certain derivative instruments such as option and forward contracts as cash flow and fair value hedges of commodity price risk where there is not a pass-through arrangement in the sales contract.
Most of the plastic packaging, Americas, sales contracts negotiated through the end of 2006 include provisions to pass through resin cost changes. As a result, we believe we have minimal, if any, exposure related to changes in the cost of plastic resin. Most of our metal food and household products packaging, Americas, sales contracts negotiated through the end of 2006 either include provisions permitting us to pass through some or all steel cost changes we incur, or they incorporate annually negotiated steel costs. We anticipate that we will be able to pass through the majority of the steel price increases that occur through the end of 2007.
In Europe and Asia, the company manages aluminum and steel raw material commodity price risks through annual and long-term contracts for the purchase of the materials, as well as certain sales of containers, that reduce the company’s exposure to fluctuations in commodity prices within the current year. These purchase and sales contracts include fixed price, floating and pass-through pricing arrangements. We also use forward and option contracts as cash flow hedges to minimize the company’s exposure to significant price changes for those sales contracts where there is not a pass-through arrangement.
Considering the effects of derivative instruments, the market’s ability to accept price increases and the company’s commodity price exposures, a hypothetical 10 percent adverse change in the company’s steel, aluminum and resin prices could result in an estimated $16 million after-tax reduction in net earnings over a one-year period. Additionally, if foreign currency exchange rates were to change adversely by 10 percent, we estimate there could be a $10.2 million after-tax reduction in net earnings over a one-year period for foreign currency exposures on raw materials. Actual results may vary based on actual changes in market prices and rates. Sensitivity to foreign currency exposures related to metal increased over prior years due to an increase in metal purchases and related payables at our foreign operations, which are subject to foreign currency fluctuations.
The company is also exposed to fluctuations in prices for utilities such as natural gas and electricity, as well as the cost of diesel fuel as a component of freight cost. A hypothetical 10 percent increase in our utility prices could result in an estimated $8.4 million after-tax reduction of net earnings over a one-year period. A hypothetical 10 percent increase in our diesel fuel surcharge could result in an estimated $1.9 million after-tax reduction of net earnings over the same period. Actual results may vary based on actual changes in market prices and rates.
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Interest Rate Risk
Our objective in managing exposure to interest rate changes is to limit the impact of interest rate changes on earnings and cash flows and to lower our overall borrowing costs. To achieve these objectives, we use a variety of interest rate swaps and options to manage our mix of floating and fixed-rate debt. Interest rate instruments held by the company at December 31, 2006 and 2005, included pay-fixed interest rate swaps. Pay-fixed swaps effectively convert variable rate obligations to fixed rate instruments.
Based on our interest rate exposure at December 31, 2006, assumed floating rate debt levels throughout 2007 and the effects of derivative instruments, a 100 basis point increase in interest rates could result in an estimated $9.1 million after-tax reduction in net earnings over a one-year period. Actual results may vary based on actual changes in market prices and rates and the timing of these changes.
Foreign Currency Exchange Rate Risk
Our objective in managing exposure to foreign currency fluctuations is to protect foreign cash flows and earnings associated with foreign exchange rate changes through the use of cash flow hedges. In addition, we manage foreign earnings translation volatility through the use of foreign currency options. Our foreign currency translation risk results from the European euro, British pound, Canadian dollar, Polish zloty, Chinese renminbi, Brazilian real, Argentine peso and Serbian dinar. We face currency exposures in our global operations as a result of purchasing raw materials in U.S. dollars and, to a lesser extent, in other currencies. Sales contracts are negotiated with customers to reflect cost changes and, where there is not a foreign exchange pass-through arrangement, the company uses forward and option contracts to manage foreign currency exposures.
Considering the company’s derivative financial instruments outstanding at December 31, 2006, and the currency exposures, a hypothetical 10 percent reduction in foreign currency exchange rates compared to the U.S. dollar could result in an estimated $19.2 million after-tax reduction in net earnings over a one-year period. This amount includes the $10.2 million currency exposure discussed above in the “Commodity Price Risk” section. This hypothetical adverse change in foreign currency exchange rates would also reduce our forecasted average debt balance by $75.7 million. Actual changes in market prices or rates may differ from hypothetical changes.
Common Share Repurchases
In connection with the company’s ongoing share repurchases, the company periodically sells put options which give the purchasers of those options the right to sell shares of the company’s common stock to the company on specified dates at specified prices upon the exercise of those options. Our objective in selling put options is to lower the average purchase price of acquired shares. There were no put option contracts outstanding at the end of 2006.
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Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of Ball Corporation:
We have completed integrated audits of Ball Corporation’s consolidated financial statements and of its internal control over financial reporting as of December 31, 2006, in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.
Consolidated financial statements
In our opinion, the consolidated financial statements listed in the accompanying index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of Ball Corporation and its subsidiaries at December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for inventory in 2006.
Internal control over financial reporting
Also, in our opinion, management’s assessment, included in Management’s Report on Internal Control Over Financial Reporting appearing in Item 9A, that the Company maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control - Integrated Framework issued by the COSO. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
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A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
As described in Management’s Report on Internal Control Over Financial Reporting appearing in Item 9A, management has excluded the operations of U.S. Can Corporation (USCan) and operations of Alcan Packaging (Alcan) from its assessment of internal control over financial reporting as of December 31, 2006, because they were acquired by the Company in purchase business combinations during 2006. We have also excluded USCan and Alcan from our audit of internal control over financial reporting. USCan and Alcan are operated by wholly-owned subsidiaries of the Company and had combined assets and combined net sales representing 17 percent and 8 percent, respectively, of the related consolidated financial statement amounts as of and for the year ended December 31, 2006.
/s/ PricewaterhouseCoopers LLP
February 22, 2007
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Consolidated Statements of Earnings
Ball Corporation and Subsidiaries
(a) 2005 and 2004 have been retrospectively adjusted for the company’s change in 2006 from the last-in, first-out method of inventory accounting to the first-in, first-out method. Additional details are available in Note 7.
The accompanying notes are an integral part of the consolidated financial statements.
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Consolidated Balance Sheets
Ball Corporation and Subsidiaries
(a) 2005 has been retrospectively adjusted for the company’s change in 2006 from the last-in, first-out method of inventory accounting to the first-in, first-out method. Additional details are available in Note 7.
The accompanying notes are an integral part of the consolidated financial statements.
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Consolidated Statements of Cash Flows
Ball Corporation and Subsidiaries