O-I Glass, Inc. (Owens-Illinois, Inc.) — Q3 2011 Form 10-Q
Business context and period: Unaudited results for the three and nine months ended September 30, 2011, compared with the corresponding 2010 periods. The company manufactures glass containers and reports Europe, North America, South America, and Asia Pacific as its operating segments. Amounts below are in U.S. dollars; financial statement amounts are in millions unless noted.
Key financial results
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net sales | $1,862 | $1,689 | $5,540 | $4,905 |
| Gross profit | $387 | $360 | $1,075 | $1,042 |
| Gross margin | 20.8% | 21.3% | 19.4% | 21.2% |
| Segment operating profit | $269 | $279 | $693 | $743 |
| Continuing earnings attributable to company | $119 | $127 | $263 | $341 |
| Net earnings attributable to company | $116 | $139 | $261 | $365 |
| Diluted EPS, continuing operations | $0.72 | $0.77 | $1.58 | $2.04 |
Q3 diluted net EPS was $0.70 versus $0.84; nine-month diluted net EPS was $1.57 versus $2.18. Segment operating profit is a management measure, not a GAAP measure when presented outside the financial statement notes.
Cash flow, debt and liquidity
- Nine-month cash from continuing operations was $281 million, down from $370 million. Capital spending was $204 million versus $389 million; company-defined free cash flow was $77 million versus negative $19 million.
- Cash fell to $256 million at September 30 from $640 million at December 31, 2010. Total debt, including current maturities, was approximately $4.1 billion; long-term debt was $3.743 billion and current debt/loans were $345 million. Cash and debt were $657 million and approximately $4.3 billion at September 30, 2010.
- Current assets were $2.639 billion and current liabilities $2.113 billion. The European receivables securitization balance was $233 million, included in short-term loans.
- A new secured credit agreement was signed in May 2011, with a $900 million revolving facility and term loans; $767 million of credit remained unused. The company reported covenant compliance and a 2.93% weighted-average rate on agreement borrowings.
Material changes and management commentary
- Q3 sales rose 10%; glass shipments by tonnes increased 4%, reflecting acquisitions and organic growth, improved pricing, and favorable currency movements. Nine-month sales rose 13%, with shipments up nearly 6%.
- Despite sales growth, segment operating profit declined 4% in Q3 and 7% year to date. Management cited $55 million of Q3 cost inflation and $164 million for the first nine months, primarily raw materials, labor, and energy, partly offset by pricing, volume, and cost savings.
- Regional performance diverged: Q3 South America segment profit increased to $67 million from $56 million; Asia Pacific fell to $23 million from $37 million. Nine-month North America and Asia Pacific profit fell $34 million and $49 million, respectively. Two North American furnaces restarted in Q3, helping stabilize supply and inventory after second-quarter production problems.
- Interest expense rose to $70 million in Q3 from $61 million and to $246 million for nine months from $177 million. The nine-month amount included $25 million in note repurchase premiums and write-off of financing fees related to refinancing and redemption of 2014 notes.
- Q3 earnings included $29 million of restructuring and asset impairment charges; nine-month restructuring and impairment charges were $41 million, including headcount-related actions. The company closed an Australian furnace in Q3 and planned to close another in early 2012; further actions depend on demand and contract negotiations.
- Management expected a 21.5% full-year 2011 effective tax rate, excluding items it considers nonrecurring, versus 26.2% in 2010; the rate may vary with the geographic mix of earnings. It expected about $60 million of 2011 non-U.S. pension contributions and estimated 2012 contributions across plans could be $30–$40 million higher than in 2011.
- The company said operating cash flow and available credit should fund working capital, capital spending, debt service, and asbestos obligations. It did not provide a specific revenue or earnings forecast.
Risks, contingencies and unusual items
- Asbestos claims remained a significant uncertainty: approximately 5,300 plaintiffs and claimants were pending at September 30, 2011, and the company said ultimate liability cannot reasonably be estimated. Recorded asbestos-related liabilities totaled $374 million ($170 million current and $204 million long term). A nearly $90 million jury award against four defendants included $40 million punitive damages against the company; the company disputed the verdict and made no accrual change.
- Venezuela expropriated two subsidiaries in 2010. The company initiated World Bank ICSID arbitration on September 26, 2011, seeking compensation; amount and timing of any recovery remain uncertain and any compensation will be recorded when received.
- Goodwill was $2.762 billion. The company was conducting its annual impairment review and warned that completed planning and restructuring assessments could result in impairment; Asia Pacific goodwill was $641 million, and management said its cushion had declined from 24% at the prior annual test.
- Other risks cited include inflation and energy costs, currency movements, economic conditions in Europe and Australia, customer demand and packaging preferences, supply-chain execution, restructuring outcomes, and asbestos claims. The company reported no material changes in market-risk disclosures or risk factors from its 2010 Form 10-K.
- VDL, a glass-container plant in France, was acquired August 1, 2011. The company also purchased the noncontrolling interest in its southern Brazil operations during the year.
Investor verification priorities
- Track whether pricing and surcharges offset ongoing raw-material, labor, and energy inflation and whether segment margins recover.
- Assess cash conversion and working-capital needs, given the $384 million cash decline and weaker operating cash flow.
- Review debt maturities, covenant headroom, refinancing costs, and the availability and terms of the secured credit facility.
- Monitor Australian demand, furnace closures, North American production stability, and potential Asia Pacific goodwill impairment.
- Follow asbestos claim trends, potential liabilities and payments, and the outcome and recoverability of the Venezuela arbitration.
- Compare actual full-year tax rates and pension contributions with management’s estimates.