OI

O-I Glass, Inc. (Owens-Illinois, Inc.) 10-Q Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly and six-month periods ended June 30, 2006. Owens-Illinois, Inc. operates in the rigid packaging industry with two primary segments: Glass Containers (Europe, Americas, Asia Pacific) and Plastics Packaging (primarily North America healthcare and prescription containers). The company is a large accelerated filer with 153,500,629 shares of common stock outstanding as of June 30, 2006.

Key Financial Metrics

Note: Operating cash flow for the six months ended June 30, 2006, was negative $95.7 million, compared to negative $51.8 million in the prior year period.

Material Changes vs. Prior Period

• Revenue Growth: Consolidated net sales increased 5.0% in Q2 and 3.4% for the six months ended June 30, 2006, compared to 2005. The Glass Containers segment drove this growth with higher unit shipments (beer/beverage) and improved pricing, partially offset by unfavorable foreign currency rates in the six-month view.
• Profitability Decline: Net earnings dropped significantly, down 50.6% in Q2 and 67.2% for the six months. This was primarily due to inflationary cost increases (energy, raw materials) and higher interest expenses, which outweighed revenue gains and productivity improvements.
• Segment Performance:
  • Glass Containers: Segment Operating Profit decreased $25.4 million in Q2 and $61.5 million for the six months. Higher energy costs ($43.4M in Q2, $94.9M in 6M) and other inflationary costs were the primary drivers.
  • Plastics Packaging: Segment Operating Profit decreased $5.8 million in Q2 and $5.0 million for the six months, largely due to the divestiture of the Asia Pacific plastics business in late 2005.
• Debt Refinancing: On June 14, 2006, the company entered a new Secured Credit Agreement, refinancing previous debt. This resulted in a $10.2 million write-off of unamortized finance fees included in interest expense.

Guidance, Outlook, and Risks

• Asbestos Litigation: The company faces substantial asbestos-related liabilities. Cash payments for asbestos costs were $80.7 million for the six months ended June 30, 2006, compared to $86.3 million in 2005. Management expects total 2006 payments to be moderately lower than 2005. The company has accrued approximately $2.99 billion (pre-insurance) through 2005 but states the ultimate liability cannot be estimated with certainty.
• Pension Obligations: A significant risk exists regarding pension accounting. If the Accumulated Benefit Obligation (ABO) of U.S. or Australian plans exceeds plan assets at the December 31, 2006 measurement date, the company may be required to write off prepaid pension assets, potentially resulting in a non-cash charge of $310 million to $320 million to other comprehensive income. Proposed FASB standards could further impact net worth.
• Goodwill Impairment: The company recorded a $494.0 million goodwill impairment charge in Q4 2005 for its Asia Pacific Glass unit. Management will monitor conditions throughout 2006; further write-downs could materially affect results if projected cash flows decline or the cost of capital increases.
• Outlook: Management anticipates that operating cash flows and available credit ($562.2 million unused under the new agreement) will be sufficient to fund operations, debt service, and asbestos obligations.

Investor Verification Checklist

• Asbestos Accrual Adequacy: Verify the assumptions used for the $650.4 million total asbestos liability (current + long-term) and the potential for future charges given the volatility of litigation.
• Pension Asset Valuation: Monitor the fair value of pension assets versus the Accumulated Benefit Obligation (ABO) leading up to the December 31, 2006 measurement date to assess the risk of a significant non-cash charge.
• Energy Cost Exposure: Review the company's hedging strategies for natural gas and fuel oil, as energy costs were a primary driver of margin compression in the Glass Containers segment.
• Debt Service Capacity: Assess the impact of the new Secured Credit Agreement terms and the recent $150 million repurchase of Senior Secured Notes on future liquidity and interest coverage ratios.
• Foreign Currency Impact: Evaluate the sensitivity of European and Asia Pacific operations to currency fluctuations, which negatively impacted sales in the six-month period.