Business Context and Reporting Period
Owens-Illinois, Inc. (the filing entity; identified in the request as O-I Glass, Inc.) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2011. The company manufactures glass containers and reports four geographic segments: Europe, North America, South America, and Asia Pacific. Comparisons below are with the corresponding 2010 periods; amounts are in millions of dollars unless stated otherwise.
Key Financial Metrics
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net sales | $1,959 | $1,670 | $3,678 | $3,216 |
| Gross profit | $355 | $383 | $688 | $682 |
| Gross margin | 18.1% | 22.9% | 18.7% | 21.2% |
| Segment operating profit | $225 | $271 | $424 | $464 |
| Continuing earnings attributable to company | $71 | $132 | $144 | $214 |
| Net earnings attributable to company | $73 | $141 | $145 | $226 |
| Diluted EPS, continuing operations | $0.42 | $0.79 | $0.86 | $1.27 |
| Interest expense | $100 | $60 | $176 | $116 |
Q2 sales rose 17%; management cited over 6% higher shipment tonnage, 2010 acquisitions, and favorable currency effects. For the first six months, sales increased 14% and shipment tonnage rose 7%. Despite higher sales, Q2 gross profit and segment operating profit declined, reflecting inflation and operational pressures.
For the six months, cash provided by continuing operations was $92, versus $149 in 2010; total operating cash flow was $94. Capital spending on continuing operations was $153, and company-defined free cash flow was negative $61, compared with negative $86 a year earlier. Investing used $300, including $147 for acquisitions, primarily purchase of the noncontrolling interest in southern Brazil operations. Financing used $188. Cash ended June at $260, down from $640 at December 31, 2010.
At June 30, total debt was approximately $4.34 billion: $371 current and $3.969 billion long-term. The company reported $631 of unused capacity under its new credit agreement and a 2.89% weighted-average rate on its outstanding borrowings under that agreement. Current assets were $2.751 billion and current liabilities $2.192 billion. Asbestos-related liabilities on the balance sheet totaled $408 million, current and long-term combined.
Material Changes Versus Prior Period
- Q2 segment operating profit fell $46 (17%); six-month segment operating profit fell $40 (9%). Sales-volume gains and currency benefits were more than offset by manufacturing and delivery costs.
- Q2 manufacturing and delivery costs included approximately $60 of inflation, $26 of North American production and supply-chain costs, and $10 from lower Asia Pacific production. For the first six months, management cited $109 of inflation, $26 of North American operational issues, $10 from lower Asia Pacific production, and $9 of Australian flood costs; offsets included $70 primarily from improved capacity utilization and prior footprint realignment.
- North America sales and profit weakened in Q2 amid low inventories and production disruptions. Europe and South America reported higher segment profit, while Asia Pacific profit declined substantially.
- Interest expense rose in both comparison periods. The 2011 amounts include $25 of note-repurchase premiums and write-off of unamortized financing fees; excluding these items, management attributed the increase mainly to acquisition-related debt issued in 2010.
- Q2 2010 included $12 of discontinued-operation earnings, versus $2 in Q2 2011. The Venezuelan subsidiaries had been expropriated in October 2010 and deconsolidated by year-end.
Outlook, Risks, Contingencies, and Unusual Items
- Management expected European energy costs to remain higher for the rest of 2011; an energy surcharge was intended to offset some of the increase in the second half, with the remainder expected to be recovered through higher prices in 2012. South American inflation recovery through price increases was expected to begin in Q3 2011.
- The company planned to rebuild North American inventories by increasing production during the seasonally slower second half of 2011, after restarting two furnaces and shifting inventory from other regions. The ERP implementation in North America was delayed from 2011 to early 2012 to focus on operational issues.
- In Asia Pacific, the company had curtailed production and closed one machine line, and was developing further restructuring steps to align Australian capacity with weaker demand. Management said Asia Pacific goodwill was $699 and that the segment’s valuation cushion had declined from 24% at October 1, 2010; it was reviewing business plans and restructuring implications.
- Management expected a 2011 full-year effective tax rate of approximately 24%, excluding items it considered nonrepresentative, compared with 26.2% in 2010; the rate could be lower depending on the geographic earnings mix. No full-year sales or EPS guidance is provided in the supplied filing text.
- The new secured credit agreement, entered May 19, 2011, refinanced the prior facility and certain 2014 notes; the euro-denominated 2014 notes were redeemed June 7. It includes a leverage-ratio covenant and restrictions on specified transactions. The company said it was covenant-compliant at June 30 and expected to remain so. Borrowings are secured by substantially all assets, excluding real estate, of domestic and certain foreign subsidiaries, with subsidiary guarantees.
- Asbestos exposure remains a significant contingency. The company reported approximately 5,700 pending plaintiffs and claimants, plus about 500 claims it believes may be asserted later. It said ultimate asbestos liability cannot reasonably be estimated. A March 2011 verdict included $40 of punitive damages against the company; it denied the allegations, planned to challenge the verdict, and made no change to its accrual. The filing notes that future asbestos charges could materially affect results and that payments use significant cash.
- The company is negotiating with Venezuela regarding compensation for the expropriated operations but could not predict the amount or timing; any compensation would be recorded when received. Other identified risks include currency movements, input and energy costs, supply-chain execution, demand in Australia and New Zealand, and the ability to pass cost increases through to customers.
Important Facts for Investors to Verify
- Whether North American production and inventory recovery improved after Q2, and whether the resulting costs and missed sales persisted.
- Whether price increases and surcharges offset raw-material, labor, energy, and transportation inflation as management expected.
- Progress and costs of the Asia Pacific restructuring, and any subsequent change in goodwill impairment risk.
- Debt, cash, available revolving capacity, refinancing needs, and ongoing compliance with the new agreement’s leverage covenant.
- Changes in asbestos claim activity, payments, verdicts, and estimates, including the appeal and any eventual exposure from the cited verdict.
- Any developments in Venezuelan compensation negotiations and the timing or amount of any recovery.
- The filing reports $27 of Q2 and $32 of six-month reductions in 2011 continuing earnings attributable to the company from items management considered nonrepresentative; investors should review the underlying adjustments and their treatment in comparisons.