O-I Glass, Inc. quarterly report, Q2 FY2016

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O-I Glass, Inc. (Owens-Illinois, Inc.) — Q2 2016 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2016. Unaudited results; dollars in millions except per-share amounts. The filing is under the name Owens-Illinois, Inc.

Business context and performance

The company manufactures glass containers and reports four geographic segments: Europe, North America, Latin America and Asia Pacific. Results include the Vitro food and beverage glass business acquired September 1, 2015, so year-over-year growth reflects the acquisition as well as underlying performance.

  • Q2 revenue: $1,760, up 14% from $1,543. Vitro contributed about $234; currency reduced sales by $31. Excluding Vitro, shipments rose about 1%, but unfavorable mix largely offset the increase.
  • Q2 earnings: Gross profit was $342 versus $274, with gross margin of approximately 19.4% versus 17.8%. Continuing-operations earnings attributable to the company were $107, or diluted EPS of $0.65, versus $42 and $0.26. Net earnings attributable to the company were $105, or diluted EPS of $0.64.
  • First-half revenue and earnings: Revenue was $3,348, up 13% from $2,964. Continuing-operations earnings attributable to the company were $175, or diluted EPS of $1.07, versus $113 and $0.69. Gross margin was approximately 19.7% versus 18.3%.
  • Segments: Q2 segment operating profit totaled $233, up 25% from $187; Vitro contributed about $44. Europe, North America and Latin America improved, while Asia Pacific declined to $11 from $14. Latin America’s reported increase included Vitro; excluding the acquisition, regional shipments were down about 7% in Q2 amid Brazil’s economic slowdown.
  • Costs and margins: Higher prices helped, but inflation raised operating costs, notably energy and soda ash in Brazil and costs and furnace downtime in Asia Pacific. Management cited improved European operating performance and lower energy costs there.

Cash flow, debt and liquidity

  • First-half operating cash flow: Cash used in continuing operations was $107 versus $110 in 2015. Working capital used $491, reflecting normal first-half seasonality. Capital expenditures were $207; company-defined free cash flow was negative $314 versus negative $318.
  • Cash and debt: June 30 cash was $334. Total debt was approximately $5.9 billion, compared with $3.8 billion at June 30, 2015, largely reflecting Vitro acquisition financing. Long-term debt was $5,549 and current debt/short-term loans were $305.
  • Credit and covenant position: The company reported a 2.57% weighted-average rate on amended credit-facility borrowings and compliance with covenants at June 30. The filing gives two different figures for unused credit: $636 in the debt footnote and $586 in MD&A; verify the correct availability. The leverage covenant maximum was 5.0x through Q3 2016, stepping down thereafter.
  • Management said operating cash flow and available credit should fund operating and seasonal working-capital needs, debt service and other obligations. Accounts-receivable factoring was $300 at June 30.

Changes, outlook and significant matters

  • Vitro contributed $444 of first-half sales and $86 of segment operating profit. Foreign exchange reduced first-half sales by $93 and segment operating profit by $16. Excluding Vitro, shipments were slightly higher, but mix weighed on sales.
  • Reported Q2 net interest expense fell to $67 from $74, but the 2015 comparison included $28 of note-repurchase premiums and finance-fee write-offs. Excluding those items, current-quarter net interest expense was up $21, principally due to higher acquisition-related debt. For the first half, reported interest expense was $133 versus $121; excluding the 2015 items, it increased $40.
  • Management expected a 2016 full-year effective tax rate of 25%–26%, versus 24.6% for 2015 excluding specified unusual items. It did not provide full-year revenue or earnings guidance in the supplied filing text.
  • Management estimated Brexit-related currency effects could reduce Europe segment operating profit by approximately $5–$10 for the rest of 2016, using June 30 exchange rates. European pricing was expected to remain lower for the rest of the year, though the year-over-year decline was expected to ease.
  • Asbestos: The company disclosed about 2,000 pending plaintiffs and claimants. The balance sheet shows $793 of asbestos liabilities at June 30 ($130 current and $663 long-term). The company had revised its estimation method and restated 2013–2015 financial statements; it said reasonably possible losses could exceed the amount recognized, with estimates potentially as high as $950. Outcomes depend on uncertain future claims, costs and litigation assumptions.
  • Controls and SEC inquiry: Disclosure controls were ineffective at June 30 because of a material weakness in controls over estimating liabilities for unasserted asbestos claims. The company expected remediation as part of its annual asbestos review in Q4 2016. It disclosed that the SEC’s Enforcement Division opened an investigation into asbestos-related accounting and control matters; the company was cooperating and could not predict the outcome or quantify potential effects.
  • Other contingencies: A subsidiary’s ICSID award against Venezuela exceeded $485 including interest, but collection remains uncertain and the award was not recognized. A separate arbitration is pending. A China joint-venture dispute also remained unresolved. The prior FCPA inquiries were closed without enforcement action.
  • Other unusual items included $19 of first-half restructuring charges, partly offset by a $7 gain on China land compensation. A Latin American plant closure accounted for $14 of restructuring charges. The Vitro purchase-price allocation remained provisional, with completion expected by Q3 2016.

Important facts for investors to verify

  • Reconcile the filing’s conflicting unused-credit disclosures of $636 and $586, and monitor the leverage-covenant step-downs.
  • Review the asbestos restatement, estimation assumptions, $950 reasonably possible loss disclosure, SEC investigation and remediation progress.
  • Assess whether acquisition-driven growth and Vitro integration translate into sustainable cash generation, given negative first-half free cash flow and higher debt.
  • Track currency, inflation, Brazil demand, Asia Pacific furnace downtime and the disclosed Europe pricing and Brexit-related impacts.
  • Confirm the status and timing of the unrecognized Venezuela award and the final Vitro purchase-price allocation.