Business context and reporting period
Owens-Illinois, Inc. filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2016. The company manufactures glass containers and reports four geographic segments: Europe, North America, Latin America, and Asia Pacific. Amounts below are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Results include the Vitro glass-container business acquired September 1, 2015. Vitro contributed $162 million of third-quarter 2016 sales and $606 million of sales in the first nine months of 2016, making reported year-over-year growth substantially acquisition-driven.
Financial performance and position
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net sales | $1,712 | $1,566 | $5,060 | $4,530 |
| Gross profit | $336 | $276 | $997 | $818 |
| Earnings from continuing operations attributable to the company | $111 | $18 | $286 | $131 |
| Net earnings attributable to the company | $108 | $17 | $280 | $128 |
| Diluted EPS, continuing operations | $0.68 | $0.11 | $1.75 | $0.81 |
| Segment operating profit | $237 | $199 | $681 | $554 |
- Gross margin was approximately 19.6% in Q3 2016 versus 17.6% a year earlier; for the nine-month periods it was approximately 19.7% versus 18.1%.
- Operating cash flow from continuing operations was $226 million for the first nine months, versus $106 million. Capital expenditures were $310 million; company-defined free cash flow was negative $84 million, improved from negative $193 million.
- Cash was $294 million at September 30, 2016. Total debt was approximately $5.6 billion; unused credit under the amended agreement was $880 million. The company reported covenant compliance. Current assets were $2,442 million and current liabilities $2,033 million.
- Net interest expense was $199 million for the nine months, versus $188 million reported in 2015. Excluding 2015 debt-repurchase premiums and finance-fee write-offs, management said comparable interest expense increased $53 million, primarily due to acquisition-related debt.
Material changes versus the prior comparable period
- Q3 net sales rose 9%, while nine-month sales rose 12%. Excluding Vitro, Q3 shipments declined about 2%, primarily amid economic weakness in Brazil and Ecuador; nine-month shipments were comparable, before unfavorable sales mix and currency effects.
- Vitro contributed $37 million of Q3 and $123 million of nine-month segment operating profit. Organic volume, currency, and cost inflation partly offset acquisition and pricing contributions.
- For the first nine months, foreign exchange reduced sales by $93 million and segment operating profit by $20 million. Latin America’s reported sales and profit benefited significantly from Vitro, while underlying regional performance faced weak volumes and higher input costs.
- Reported earnings comparisons also reflect prior-year charges. Management estimated items it viewed as non-recurring reduced attributable earnings by $74 million in Q3 2015 and $130 million in the first nine months of 2015, compared with $10 million in the 2016 nine-month period.
- Cash declined $105 million from year-end 2015. Working capital used $320 million in the first nine months, which the company attributed to normal seasonality; the period included a $127 million value-added-tax refund related to Vitro.
Outlook, risks, contingencies, and unusual items
- Management expected a full-year 2016 effective tax rate of approximately 24% and stated it expected operating cash flow and available credit to cover operating and seasonal needs, debt service, and other obligations. No specific earnings or sales guidance is provided in the supplied filing text.
- Management cited continued European pricing pressure, foreign-exchange exposure, inflation in energy and raw materials, economic weakness in parts of Latin America, acquisition integration and synergy execution, and debt/refinancing and covenant risks. It estimated the UK referendum’s exchange-rate effect could reduce Europe segment operating profit by about $5 million for the remainder of 2016, using September 30 exchange rates.
- Asbestos: The company disclosed a revised estimation method and restated prior-year financial statements. The recorded asbestos liability was $817 million at December 31, 2015; the company said reasonably possible losses could be as high as $950 million above the amount recognized, and ultimate liability could exceed that estimate. The September 30 balance sheet lists $130 million current and $643 million long-term asbestos liabilities. Approximately 1,600 plaintiffs and claimants were identified as pending at September 30.
- Controls and SEC inquiry: The SEC Enforcement Division was investigating accounting and control matters concerning asbestos liability estimates. The company could not predict the outcome or quantify potential effects. Management concluded disclosure controls were ineffective at September 30 due to a material weakness in controls over estimating liabilities for unasserted asbestos claims; remediation was expected to be completed with the 2016 annual asbestos review.
- Venezuela: A previously issued arbitration award exceeded $485 million including interest, but collection remains uncertain and the award was not recognized in the financial statements. A separate arbitration is pending. Discontinued-operation losses were $6 million for the nine months.
- A dispute involving the company’s China joint venture, in which its investment was about $72 million, remained unresolved, with legal actions on hold while discussions with the new partner continued.
Important facts for investors to verify
- Review the asbestos liability assumptions, the $950 million reasonably possible additional-loss estimate, and progress and results of the control-remediation work and SEC investigation.
- Separate Vitro’s contribution from underlying volume, pricing, currency, and cost trends, particularly in Latin America.
- Track debt, available revolver capacity, leverage-covenant headroom, and the effect of interest costs on cash generation.
- Assess seasonal working-capital requirements, capital spending, and the sustainability of operating cash flow given negative nine-month free cash flow.
- Monitor the enforceability and collectability of the Venezuela award and developments in the China joint-venture dispute.